Sunday, May 15, 2022

Economic and Market Update

 The Economy

Consumer Sentiment - The Index of Consumer Sentiment, provided by the University of Michigan, tracks consumer sentiment in the US based on surveys of random samples of US households. The most recent data was released Friday. The current level of 59.10 decreased from 65.20 last month and from 82.90 one year ago, and the lowest level since 2011. This data, though not conclusive, would suggest we may be in a recession now. Consumer sentiment typically bottoms at the trough of a recession when consumers are under the most stress.


Inflation - The Consumer Price Index (CPI) is at 8.26%, down from 8.54% last month and 4.16% a year ago. The long-term average is 3.25%. Some believe that inflation may have already peaked and will begin declining. Here's the thing to know. The inflation rate is the rate of change, not the level of prices. Even though the inflation rate may fall, prices may remain elevated, just not rise at the same rate. Some of the inflation is now coming from increasing wages. For example, the supply of chickens may normalize, but the salaries paid to process the chickens are sticky. It is difficult to cut an employee's wages once raised.


Employment - The Unemployment Rate is unchanged from the previous month at 3.60%, down from 6.00% a year ago. The long-term average is 5.75%. The Job Openings and Labor Turnover Survey compared to the number of unemployed persons shows there are 1.9 job openings for every unemployed person. It would be difficult to have a deep recession with below-average unemployment. Unfilled jobs need to be reduced, and the unemployment rate may need to rise to get inflation under control. 


GDP – First quarter Gross Domestic Product (GDP) was -1.4%, following +6.9% in the fourth quarter of 2021. It is often cited that a recession begins with two consecutive quarters of negative GDP, of which this could be the first. The biggest detractor from first-quarter GDP was a drop in exports; it could be that the first-quarter surge in Omicron impacted GDP.


Recession – The economy is constantly expanding and contracting. A recession is an extended period of economic contraction usually characterized by high unemployment and declining equity prices. The New York Federal Reserve publishes the Probability of US Recession in the coming 12 months, and the current probability is 3.71%.


I do not see a recession developing in 2022. The US economy is a big ship to turn, and there are reasons to believe that a recession may not materialize. However, when the Federal Reserve raised interest rates in the past, it often resulted in a recession and makes a 2023 or 2024 recession more likely. In an interview with NPR Thursday, Federal Reserve Chairman Jerome Powell warned that he could not promise a soft landing, meaning getting inflation back to the Fed's 2% target while maintaining full employment may not be possible. The Fed may need to raise interest rates to the point that the economy slows enough to eliminate the current job surplus and cause some layoffs to get inflation under control. The stock market is a leading economic indicator suggesting that the recent market volatility may be market participants repricing what they are willing to pay for stocks in a period of slower economic growth.


Equity Markets

Markets remain volatile as market participants adjust to higher interest rates and a less accommodative Federal Reserve. Adding to the uncertainties are the war in Ukraine and the ongoing COVID-19 lockdowns in China. The world's second-largest wheat producer, India, has now banned wheat exports following lower than expected crop yields due to drought. Their food security was cited as the reason. Wheat prices on the global market have been rising, and banning exports may lower the domestic price in India while creating further shortages elsewhere. It was expected that India would be able to make up for some of the lost Ukrainian supply. There will be food shortages in parts of Asia and Africa. It's difficult to discuss the economic impact of war, pandemics, and potential famine without sounding insensitive. Our thoughts and prayers continue to go out to the people affected. I expected markets would be volatile in the first half of the year due to Fed policy changes. The geopolitical issues and the relentless pandemic further complicate market outlooks.


Earnings – Stock prices are a function of earnings. So far, 454 companies in the S&P 500 have reported their first-quarter earnings; most are beating estimates. Next week we get the Retail Sales report and earnings reports from Walmart, Target, Home Depot, and Lowes. These reports should give us a good indication of consumer spending, but consumers may have shifted from buying things to doing things.


Market levels – The level of the S&P 500 comprises two components. The first is earnings estimates. These are estimates of future earnings provided by companies to their shareholders and analysts who study and follow the companies. 2022 earnings estimates for the S&P 500 range from $210 to $245; let's use the average of $227.50. The second component is the earnings multiple. The earnings multiple is a value assigned by investors that reflects investors' confidence in the future earnings estimates in relation to the potential return on investment alternatives like bonds. It's how we think of the market as cheap or expensive when considering expected earnings. In recent years the multiples have ranged from 18 to 23. Pre-pandemic, we were trading at 19 times forward estimated earnings. Over the past 25 years, the average earnings multiple has been around 16. What we've seen so far this year is not necessarily economic weakness but instead falling confidence and multiple compression. Just as consumer confidence is falling, so is investor confidence. Investors believe that the Fed will raise interest rates and slow economic growth, so they have lowered the multiple they are willing to pay for the estimated growth. So far, most first-quarter corporate earnings have beat estimates, and analysts have not reduced their expectations for future earnings, they may in the future, but for now, we have to work with the data we have.


01/03/22 - S&P 500 4796 = $227.50 x 21.08

02/28/22 - S&P 500 4373 = $227.50 x 19.22

04/29/22 - S&P 500 4131 = $227.50 x 18.15

05/12/22 - S&P 500 3930 = $227.50 x 17.27

??/??/??  - S&P 500 3640 = $227.50 x 16.00


What makes being underinvested ill-advised is that there is so much negativity being priced into markets that markets could rise quickly if anything good happens. Suppose there was good news on the war in Ukraine or fewer lockdowns in China. What if we see supply chain improvement and lower inflation? These could cause market participants to begin multiple expansions or cause earnings estimates to rise, and the S&P 500 could also quickly rise.


If inflation persists, we want exposure to investments in areas where companies can pass on higher prices to consumers. That would be things like Energy and Consumer Staples. If we enter a recession, we want to be overweight areas that do better later in the business cycle, including Energy, Utilities, Healthcare, and Consumer Staples. I've added exposure to these sectors in the portfolio models. A recession is the shortest phase of the business cycle. Equity markets rise and fall in anticipation of what's coming next, meaning that equity markets may rise in the depths of a recession in anticipation of future economic growth. The economy and markets are always changing. I will continue to monitor the data and keep our clients informed.

Saturday, April 16, 2022

It’s different this time!

The four most dangerous words in finance and economics are “it’s different this time.” It’s not; it never is, though there are always those who want to force a set of facts to fit their outlook.  

I often look to history as a guide to what might happen next. And yet we find ourselves at a unique time in history. We are emerging from a global pandemic; there is an active war in Europe, inflation is at multidecade highs, and the Federal Reserve is raising interest rates when the economy shows signs of slowing. Parts of the bond yield curve have inverted, there are recession fears, and yet companies have more job openings than we have people. We have experienced all these conditions at times in the past and can glean insight from what happened next, but we’ve never had a time when all these conditions coincided.

Part of what makes finance and economics so interesting is that it sits at the intersection of the unyielding constant of mathematics and the predictable unpredictability of people. Mark Twain said, “The past does not repeat itself, but it rhymes.” So, where can we find the rhymes?

We are headed for a recession! That sounds scary, but the reality is that we are always headed towards a recession. The economy naturally expands and contracts. We want to know where we are in that cycle and the financial impact of the next contraction. Previous recessions have been preceded by an inversion of the bond yield curve. We saw a short-lived inversion of the yield between the two-year Treasury and the ten-year Treasury, which has preceded some recessions by six to twenty-four months. We are now watching the spread between the three-month Treasury and the ten-year Treasury for confirmation of an inverted yield curve. This inversion has not yet happened and is now showing signs of steepening. If this part of the yield curve inverts, I would expect a recession is on the horizon. I see the risks of a recession in 2022 as low. The low unemployment rate means that people have the income to spend on goods and services in the economy. It would be difficult to experience a significant contraction during a period of such low unemployment. We also need to remember that many of those employed contribute to an employer-sponsored retirement plan. Every month we see inflows to markets from payroll deferrals.

I’ve shared that I thought the first half of the year would be more volatile than the second half. Increased volatility should be expected when the Federal Reserve changes monetary policy. The war in Ukraine adds to the economic uncertainty and may extend the period of volatility, and we’ve yet to see the impact of the mid-term elections.

I expect the S&P 500 to trade between 4000 and 5000 for the remainder of the year. The most pessimistic analyst I follow is Morgan Stanley which expects the S&P 500 to finish the year at 4400. Morgan Stanley Chief Markets Strategist Mike Wilson warned of a market downturn for some time; his 2021 forecast was for the S&P 500 to end 2021 at 4000, which was incorrect. One of the most optimistic analysts I follow is Brian Belski, BMO Capital Markets investment strategist, who sees the S&P 500 finishing the year at 5300. His 2021 target was 4800. The S&P 500 finished 2021 at 4766. Brian Belski was almost spot on with his outlook for 2021; perhaps he will be for 2022.

Summary: I do not see a recession in 2022. There will be increased volatility as market participants contemplate all the economic variables. I am not aware of any market analysts predicting the S&P 500 will finish the year lower than where it is now. The average of the most pessimistic and most optimistic S&P 500 targets would have the S&P 500 gaining 10% from current levels finishing the year with a small gain. I am never anchored to an outlook or opinion, and if the facts and data change, I will adjust my view.

Wednesday, April 6, 2022

Recency Bias

A powerful bias in investing is Recency Bias. Recency bias is the tendency to think that things that have happened recently are more likely to happen again or that a current trend will continue despite data and information to the contrary. Recency Bias can show up in many areas of our lives. People who have been in a serious automobile accident may drive more cautiously for a time. Someone who had a winning lottery ticket may be more inclined to buy more lottery tickets. Recency bias can be based on life experiences and our emotions. Following news of an airplane crash, some will choose not to fly despite evidence that flying is the safest form of transportation. People may be apprehensive about going into the ocean if a shark attack has recently occurred, even if the attack occurred hundreds of miles away. As time passes, if there are no more airplane crashes or shark attacks, the emotions and effects of recency bias fade.

Investors often underperform their investment benchmarks due to Recency Bias. During a bull market, investors may ignore data that suggests they should reduce their equity exposure, preferring to believe that the current upward trend will continue. Investors may also ignore positive economic data during periods of market weakness out of fear that the recent downward trend will continue. The best time to reduce equity exposure would be when markets are at highs, but that doesn’t feel comfortable. The best time to reengage with equity markets would be when markets are at their lows, but that won’t feel comfortable either. The SEC disclosure “Past performance is no guarantee of future results” cautions investors against relying on Recency Bias. Experience has taught me not to try to guess about market highs or lows and to pay more attention to the data and less to my feelings and hunches.

Recency Bias can affect our decisions even when events aren’t so recent. When made aware of a coming hurricane, people who live in the affected areas may choose to evacuate or not evacuate based on their experience with previous storms when they should evaluate the risks of the current storm based on the available data and information. When recession and inflation are in the news, people reflect on their most recent experiences during earlier times of recession and inflation though the economic fundamentals and ultimate outcomes may differ.

We can’t eliminate biases from our decision-making processes, but being aware of them and considering how much weight to give them will help us make better life and investment decisions.

Saturday, February 5, 2022

A Recession Indicator

At the beginning of the pandemic, our portfolio models were more conservatively positioned than they typically would be. I do not have a crystal ball and could not have predicted a global pandemic, but the bond yield curve inverted on August 26, 2019, signaling an increased risk of recession in the coming year. In response to the weakening economic conditions, I reduced portfolio risk and wrote several client emails outlining the concerns and the steps I was taking. Already being on Recession Watch, I probably reacted more quickly to the new health risk than I would have during other periods of the economic cycle.

  • We probably would have entered a recession in 2020 or 2021 even if the pandemic hadn't happened.

One of the most reliable indicators of a coming recession is an inversion of the bond yield curve as measured by the relationship between the yield on the Ten-Year and Two-Year Treasury Notes. Since 1955 an inversion of the yield curve has preceded all US recessions by 6 to 24 months. We are seeing some signs that the yield curve is flattening. Actions by the Federal Reserve and economic uncertainties could lead to a yield curve inversion and a subsequent recession. If this occurred, I estimate a recession would be a 2023 or 2024 event. There is nothing to do now but be aware of it and watch the data.

So, what does it mean to invert the yield curve? If we compare mortgage terms, we expect that the longer the mortgage term, the higher the interest rate should be. We expect to pay a higher rate for a 30-year mortgage than a 15-year mortgage. Likewise, investors expect to receive a greater yield on a ten-year investment than a two-year investment such as Treasury Notes. An inversion of the yield curve occurs when the current yield on the longer-term Ten-Year Treasury Note is less than the yield on the shorter-term Two-Year Treasury Note.

Two forces can work independently or together to cause a yield curve inversion. The first force is the Federal Reserve. The economy can accelerate too rapidly during an economic expansion and create inflation. The Federal Reserve may use monetary policy to curb inflation by raising short-term interest rates, causing shorter-term bond yields to rise. An inversion may occur if yields on longer-term bonds don't rise at the same rate.

The second force is investors. During periods of economic uncertainty, investors may choose to reduce their portfolio risk by increasing their allocation to fixed-income investments like bonds. A general allocation to intermediate-term bonds will include Ten-Year Treasury Notes. As demand for Ten-Year Treasury Notes rises, the yield on these bonds begins to fall. An inversion may occur if the Federal Reserve doesn't respond quickly enough to falling intermediate-term bond yields by lowering short-term interest rates or otherwise making monetary policy more accommodative.

The long-term average yield spread between the ten-year Treasury Note and the two-year Treasury Note is 0.93%. As of February 5, 2022, the spread is 0.62%, below the longer-term average but not yet close to inversion. 

Most conditions that lead to a recession and significant equity market drawdowns develop over time. The US economy is like a big ship, and it doesn't turn quickly. Wars and global pandemics that bring the global economy to a sudden stop would be exceptions. Suppose the yield curve inverts or the economy weakens significantly. In that case, I will move to a more neutral position, understanding that more conservative allocations might be appropriate within six to twelve months. The strategy remains the same. Watch the economic and market data and adjust portfolios as necessary.

Friday, November 26, 2021

Investment Objective and Risk Tolerance

Your Investment Objective is a guideline you have chosen to define your goals and help identify your risk tolerance. Risk tolerance is the level of risk of loss you're willing and able to tolerate while pursuing these goals. All investments involve some amount of risk, including the potential for the loss of principal. Generally, equities (stock-like investments) involve more risk than fixed income (bond-like investments). Equities may have the potential for higher returns but also have the potential for greater losses. The higher your risk tolerance and the longer your time horizon, the more you may want to invest in higher-risk investments. Your investment objective is a factor to help define the ratio of equities and fixed income in your account. Increasing the percentage of fixed income may reduce volatility but may also reduce your potential return.

Reducing your exposure to equities and volatility may also reduce the probability of meeting your investment goals. Currently, interest rates are historically low, and returns on fixed income are correspondingly low. Rising inflation erodes the buying power of money, making fixed-income investments even less attractive. Equities in your portfolio may serve as a hedge against inflation. If you think prices will increase, owning equity in companies raising their prices may help offset the impact of inflation.

Your investment objective can usually be found on the first page of your investment account statement. The approach I recommend is to choose an investment objective that strikes a balance between taking enough risk to realistically pursue your financial goals while also allowing you to sleep well at night. Consideration should be given to how well you're prepared to reach your financial goals.

I do not try to time or jump in and out of investment markets. I choose investments I believe may do well in the intermediate to long-term based on economic and market data, adjusting equity exposure to align with a client's investment objective. Moving towards periods of economic weakness, I may adjust equity exposure towards the lower end of the equity range. Moving into periods of economic strength, I may shift the level of equity exposure to the upper end of the range for a specific investment objective. Below are the investment objectives we use for our clients. Investors should regularly review their investment objectives to maintain alignment with their current financial goals and risk tolerance.

Aggressive Growth – 90% to 100% in equities, 0% to 10% in cash and fixed income.

Emphasis is placed on the potential for aggressive growth and maximum capital appreciation. This objective is considered to have the highest level of risk and is for investors with a longer time horizon.

For retirement planning purposes, this is generally appropriate for people with more than ten years until retirement and a higher tolerance for risk. An aggressive growth investment objective may also be suitable for those whose retirement assets are below target. 

Growth – 70% to 90% in equities, 10% to 30% in cash and fixed income.

Emphasis is placed on achieving long-term growth and capital appreciation. This objective is considered to have a moderate level of risk and is for investors with a longer time horizon.

For retirement planning purposes, this is generally appropriate for people not yet retired who have a moderate tolerance for risk. A growth investment objective may also be suitable for those whose retirement assets are below target.

Growth with Income – 50% to 70% in equities, 30% to 50% in cash and fixed income.

Emphasis is placed on modest capital growth. Certain assets are included to generate income and help reduce overall volatility. This objective is considered to have a moderate level of risk.

For retirement planning purposes, this is appropriate for investors in retirement who have a moderate tolerance for risk and whose retirement assets are on target.

Income with Moderate Growth – 30% to 50% in equities, 50% to 70% in cash and fixed income.

Emphasis is placed on current income, with some focus on moderate 

capital growth. This objective is best suited for investors with little need for capital appreciation.

For retirement planning purposes, this is appropriate for investors in retirement who have a lower tolerance for risk and whose retirement assets are above target.

Income with Capital Preservation – 10% to 30% in equities, 70% to 90% in cash and fixed income..

This objective is generally considered the most conservative investment objective. Emphasis is on generating current income and minimal risk of capital loss.

For retirement planning purposes, this is appropriate for investors in retirement who have a lower tolerance for risk and whose retirement assets are well above target.

Saturday, November 20, 2021

CAUTION! Speed Bumps Ahead

 We are in the middle of one of the seasonally strongest periods for equity markets, yet we have some potential speed bumps in the weeks ahead.

President Biden is expected to announce his pick for Federal Reserve Chairman before Thanksgiving. It is anticipated that he will either renominate current Federal Reserve Chairman Jerome Powell (R) or Fed Governor Lael Brainard (D). Many believe Chairman Powell has done an excellent job and should be renominated. Others think President Biden may choose Fed Governor Brainard as an appeasement to the more progressive wing of the Democratic party who may feel they were forced to capitulate on recent legislative issues. Both are highly qualified, and neither are expected to change the Fed's current path; however, any change at the Fed could cause a ripple through markets. I don't have any inside information, but if President Biden wants to make a change at the Fed, it may come after the market closes Wednesday, giving market participants something else to digest with their Thanksgiving turkey.

We're about to revisit the debt ceiling drama. You may recall that Congress approved an extension of the national debt limit in October. U.S. Treasury Secretary Janet Yellen has shifted her estimate of how long the government's debts can be paid from December 3rd to December 15th. We have never defaulted on a bond payment, and it is expected that after a period of public theater, Congress will again raise the debt limit. Defaulting on our debt is a low probability, high consequence event that could move markets as we approach a potential default. A default could result in missed bond payments, social security checks, and military payroll being delayed. Markets would have a dramatic reaction if the U.S. were to default on any debt.

After Thanksgiving, we can look forward to a potential government shutdown dominating headlines again. Congress did not pass the necessary appropriations bills in September to fund the government for the fiscal year, which started October 1st. Instead, Congress passed a (CR) Continuing Resolution to avoid a government shutdown. Congress must pass the required appropriations bills or another CR by December 3rd to avoid a government shutdown again. It is expected that Congress will opt to pass another CR, kicking the can down the road into next year. There is a risk that politics could come into play and force a temporary government shutdown. Markets do not like uncertainty or instability; however, the reality is that a government shutdown is not a permanent condition. Previous government shutdowns have not resulted in lasting economic harm.

After impressive 2021 market returns, many are sitting on significant taxable gains. With the threat of changes to the tax code, some may elect to sell into yearend to realize taxable gains in 2021. If we begin to see tax-related selling, I expect those funds to come back into the markets in January.

In recent weeks we've seen a rise in COVID cases again in thirty states and areas around the globe. As winter approaches, more people in colder climates are spending more time indoors. This week Austria reinstated a lockdown and mandated vaccination for their population. In neighboring Germany, there are broad restrictions for public transportation, restaurants, and other public venues. In some places, they are canceling holiday events. When asked about a lockdown in Germany, the German health minister said nothing could be ruled out. The rise in COVID cases has caused doubt in the expectations for global growth. Crude oil prices have fallen 4% to a six-week low. Growing economies have higher energy needs. If growth estimates are revised down, the forecasts for energy prices are also revised down. Although there is nothing good about rising COVID cases, the silver lining is that a slower global recovery will put downward pressure on energy prices and inflation concerns and could give the Fed more time to adjust monetary policy.

Do you remember that time when everything was good, and there wasn't anything to worry about? Neither do I. I don't have a crystal ball; I can't see the future or defy gravity. I expect we'll have increased volatility in the coming weeks as the political issues play out. The economy is in good shape, corporate profits have been better than expected, and earnings estimates have been growing. I don't worry too much about things that could cause short-term market gyrations. I'm watching for conditions that could lead to a recession. I don't see anything like that currently. I will continue to monitor markets and the economy and will keep you advised. Please call me with any questions or concerns.

Saturday, November 6, 2021

Economic Update - November 6, 2021

 A video version of this content is available on YouTube: Link to Video Podcast

An audio version of this content is available: Link to Audio Podcast

There was a lot of market-moving economic news this week. Wednesday, the Federal Reserve ended their two-day meeting and announced their plan to begin reducing asset purchases. The Fed has been buying $120 Billion per month in bonds, $80 Billion of US Treasuries, and $40 Billion of agency mortgage-backed securities to support the bond market through the pandemic. The Fed will reduce US Treasury bond purchases by $10 Billion and agency mortgage-backed securities by $5 Billion in November and December. It is expected that the rate of decreasing bond purchases will continue, and the Feds bond-buying program will end in the Summer of 2022. Chairman Powell indicated that adjustments could be made should economic conditions change. Chairman Powell reiterated that there is a higher bar for raising the Fed funds rate; raising rates is not expected until after the Fed has completed the tapering of their bond-buying program. Many believe the Fed will begin raising interest rates later in 2022 in response to increasing inflation pressures. The Fed has done an excellent job of communicating their intended path and not being surprised markets responded well.

Thursday, the Labor Department reported that weekly initial jobless claims fell by 14,000 to 269,000. This number was better than expected and marked a pandemic period low—March 14th, 2020, pre-pandemic initial jobless claims were 256,000.

Friday, The Bureau of Labor Statistics reported that nonfarm payroll employment rose by 531,000 in October, and the unemployment rate fell to 4.6%. This report exceeded expectations, and equity markets rallied to new highs. We are all aware of the labor shortages. Unfortunately, there is no end in sight. The most recent data shows that we have more job openings than human beings to fill them. When I was in business school, an economics professor commented that full employment was 5%. He opined that anyone who wants a job has one once you fall below a 5% unemployment rate, and anyone worth hiring has been hired.

Pfizer announced results from their clinical trial of its experimental Covid-19 pill. When combined with a low dose of an HIV drug called ritonavir, hospitalization or death were reduced by up to 89% among high-risk patients. On CNBC Squawk Box, the former head of the FDA, Dr. Scott Gotlib, said, “By January 4th, this pandemic may well be over, at least as it relates to the United States after we get through this Delta wave of infection,” he said. “And we’ll be in more of an endemic phase of this virus.”

With Congress contemplating infrastructure bills, and the possibility of the pandemic coming to an end, the labor market should remain firm.

Coming into October, there were those warning that markets were at risk of a significant sell-off. Inflation, the possibility of rising interest rates, the threat from higher oil prices, and a policy misstep from the Fed were all cited as reasons the bull market could end. All those risks remain, and I will continue to monitor the economic data. You should never be so confident in your investment outlook that you discount the risks. For now, I see solid corporate profits, a strong labor market, an accommodative Fed, and a potential end to the pandemic outweighing the risks. This past Friday, I adjusted the portfolio models during a scheduled rebalance. The most recent changes increased diversification and slightly reduced risk.

We are in a seasonally strong period for equity markets. Considering the solid economic data, we could see equity markets continue their upward trajectory into year-end. As I always say. I do not have a crystal ball; I can’t see the future nor defy gravity. I can monitor markets and economic conditions and keep you informed. Please call me with any questions or concerns.

Monday, September 27, 2021

Market Update - 5%+ Correction

Link to accompanying YouTube Video: Link


Link to accompanying Podcast: Link

Monday, September 20th, the S&P 500 sold off 1.7%. It was painful to watch. By Friday, the market recovered the losses and ended the week higher. The primary reason for the sell-off was the potential loan default of Evergrande, a Chinese property development company that few had ever heard of. There was fear that the problems at Evergrande could be a symptom of a bigger problem. Over the week, global financial institutions assessed their exposure and the risk of contagion. All indications are that the financial risks are limited and could be mitigated by the Chinese government.

At the end of their October meeting, the Federal Reserves' decision not to raise interest rates or begin tapering their bond purchases calmed markets. In the press conference, Federal Reserve Chairman Jerome Powell struck the perfect balance, assuring markets that they were aware of rising inflation concerns but would remain accommodative until they were confident that the job market had stabilized. The Fed lowered their 2021 GDP forecast to 5.9% (down from 7.0% in June) and raised their GDP forecast for 2022. They acknowledged inflation is running higher than anticipated. The Fed believes that some of the inflation is temporary and will moderate once supply chains have healed.

In investing, two of the most important things to control are our emotions and our expectations.

Expectations - Market pullbacks can be unpredictable but should be expected. In this chart, we see that since 1980 there have only been three previous years without a pullback of 5% or more. There have not been two years in a row without such a pullback. A drawdown of 5% or more before year-end would be typical. To go the next 15 months without a correction of 5% or more would be a statistical anomaly.

Emotions – When markets make sharp corrections, it is normal to feel anxious. Those who have invested through recessions are reminded of how they felt during those times. Drawdowns of 20% or more that last for more extended periods, called bear markets, are often associated with slowdowns in the economy or recessions. It's important to remember that every correction does not lead to a bear market. Before making an investment change during a market pullback, separating facts from feelings is essential. Consider all the economic data to recognize the difference between a normal market correction and a market signaling future economic weakness. Emotionally driven financial decisions often don't end well.

Finally, we can be tempted to try to predict market corrections. To successfully time the market means you must be right twice. You need to know when to sell, which would be at a market top when everything seems fine, and then you would need to know when to buy, at a relative bottom when things don't feel so good. Market timing is a fools' errand. Those who have tried to time markets have lost more money than they would have lost in the correction.

At this time, I do not see any economic data that suggests we an economic recession in the foreseeable future. I will of course provide an update if I see anything that changes my view. Market corrections can be unsettling but are part of regular market activity and should be expected. Acting on changes in economic data rather than our emotions leads to better financial outcomes and less portfolio-related stress in our lives.

Sunday, July 11, 2021

Charitable Donations

Americans have a history of being charitable. According to the Giving USA Foundation's annual report, individuals, corporations, and foundations gave a record $471.44 billion to charities, social causes, and other qualified organizations in 2020. The US tax code encourages charitable giving by providing various income tax incentives to charitably minded taxpayers.


Some of the more common tax-favored charitable donation methods are Cash DonationsQualified Charitable Distributions, and the donation of Long-Term Capital Gain Property.


Cash Donations - Under the CARES Act (2020) and the Coronavirus Response and Consolidated Appropriations Act (2021), you may temporarily deduct up to 100% of your adjusted gross income donated to qualified charities and organizations provided you itemize deductions on your tax return. If you take the standard deduction, you may deduct $300 for individuals and $600 for married couples for donations made to qualified charities and organizations.


Qualified Charitable Distribution (QCD) – Donations may be made directly to a qualified charity or organization from an IRA if specific rules are followed.

·      The IRA owner must be over age 70½.

·      QCD's are limited to $100K per person.

·      The donation must be made directly from the IRA to the qualified charity or organization

·      QCD's can only be made if the donation would have been deductible if it had not been made from an IRA.


It is crucial that you accurately report a QCD on your tax return to realize this benefit. There is no code or box on the 1099-R that differentiates a QCD from other IRA distributions. The IRA custodian does not report QCD's to the IRS or the taxpayer. You must retain documentation from the qualified charity or organization as you would for a cash donation. Report the full IRA distribution on form 1040 and then the taxable amount on the appropriate line. Enter QCD in the margin next to the IRA distribution line.


Qualified Charitable Distributions most benefit those who do not itemize deductions and plan to donate more than $300 for individuals and $600 for married couples per year to qualified charities or organizations. It would also be of particular benefit to those who do not itemize deductions and are subject to Required Minimum Distribution (RMD).  Qualified Charitable Distributions count towards satisfying Required Minimum Distributions.


Long-Term Capital Gain Property – Property you've owned for more than a year may be subject to long-term capital gains tax should you sell it. One way to avoid this tax is to donate the property to a qualified charity or organization. You can generally deduct the donation's fair market value, not just your basis, up to a percentage of your Adjusted Gross Income. The donated property may include stocks, bonds, ETFs, or mutual funds. The property or shares must be transferred directly to the qualified charity or organization to realize this benefit.


Congress makes periodic changes to the tax code that may impact the income tax advantages of charitable donations for a given year. There have been multiple changes in recent years. You should consult a tax professional to determine how the tax code may apply to your charitable plans for a particular tax year. You can find more information regarding the tax treatment of Charitable Contributions in IRS publication 526.

Sunday, June 20, 2021

June Swoon

In my May 29th client email, I said, "I still expect we may see a Summer Swoon. This isn't unusual between Memorial Day and Labor Day and would not be a cause for alarm." And right on cue, a couple of weeks later, we see a June Swoon.

As we get into July, we'll begin to get second-quarter earnings announcements. I expect corporate earnings will continue to be good. Ultimately earnings and earnings expectations are what drive equity prices. Until we get into second-quarter earnings, I expect markets will remain focused on inflation and the Fed. As a result, volatility may continue.

Last Tuesday, the Federal Reserve ended a two-day meeting. In the press conference Jerome Powell, Chair of the Federal Reserve, said, "Inflation has increased notably in recent months." One of the Fed's preferred measures of inflation, (PCE) personal consumption expenditure was up 3.6% in April, and the May (CPI) Consumer Price Index was up 4.99% in May. The Fed's position is that much of the price inflation is transitory and related to the economy reopening. There is some evidence to support this theory. If you dig into the data, about a third of the spike in inflation is transportation-related. We've seen a big jump in used car prices and the cost of airfare which likely won't continue to rise at an elevated rate. Earlier this year, we also saw a spike in lumber and grain prices which have since subsided. These sharp changes will distort the inflation data until supply chains normalize. The Fed also raised its forecast for 2021 GDP to 7%, which would be the fastest growth we've seen in a long time. The Fed moved forward their timeframe for raising interest rates to 2023.

My big takeaway from the Fed meeting is that the economy is recovering faster and growing more than they thought; inflation is running hotter than they thought. As a result, they will have to tighten monetary policy by reducing bond purchases and raising interest rates sooner than they thought. So, if you are considering buying or refinancing a home or financing a large purchase, now is a good time. The Federal Reserve has told us that they plan to begin raising interest rates in 2023 or sooner.

I'm not paying much attention to those sounding the alarm of rising inflation. The reality is that nobody knows. We've never stopped the economy and increased the money supply by a third before. There isn't a playbook that guides us on what happens when you take a large economy from stop to go. The deflationary forces that have been at work for decades are still at work. I pay close attention to the bond market to inform my views on inflation. So far, the bond market is signaling that inflation isn't going to be an issue.

Economic theory tells us that the extraordinary moves central banks have taken; increasing the money supply by printing money and buying bonds, should result in inflation. The reality is that it hasn't. Japan embarked on this policy in the '90s. The rest of the world followed during the financial crisis of '08. The experts have been warning of runaway inflation in the US for more than a decade. It never materialized. My views on inflation have evolved since business school. I don't think inflation is necessarily caused by expanding the money supply but rather by what is done with that money. Inflation can only happen if people's desire and ability to spend exceeds the economy's capacity to deliver goods and services. Suppose central banks distribute currency and people pay down debt, increase savings or purchase non-productive assets like cryptocurrencies. In that case, the new money creates little pressure on the supply or prices of goods and services. The bottom line is we're just too early in the reopening process to determine that inflation trends have made a lasting change.

Nothing in the Fed statement or the economic data suggests a recession or slowing of the economy, which I would be concerned about. Some market participants are reacting to the possibility that the Fed may have to take steps to slow the economy in the future. It gives perspective to say it out loud. The Fed may have to take steps to slow the economy in a year or two. So, our strategy remains the same. Watch the data and adjust accordingly. Ignore the noise and emotion.