“In theory there is no difference between practice and theory. “In theory there is no difference between practice and theory. In practice, there is.” – Yogi Berra.
When revisiting our newsletter from this time last year, one might be surprised by how fast the economy has changed. Back then, we were debating whether inflation would be transitory or sustained. In theory, the medicine for high inflation is inflation itself – in that consumers slow down their purchases of high-priced goods until prices level off. In practice, as the Federal Reserve kept interest rates low and Americans maintained strong balance sheets, inflation has persisted with further fuel from rising commodity prices in reaction to the Ukraine-Russia war.
• The S&P 500 finished down about 21% for the first half of 2022, its worst six month start to a calendar year since 1970. Bonds in aggregate are also down 11% due to rising interest rates, giving the feeling that “nothing worked” (this is especially true of Bitcoin which is down 60% YTD).
• International stocks have slightly outperformed U.S. stocks, but were still down 19.5% to start the year. Both U.S. and foreign stocks are now trading at price-to-earnings valuations below their 25-year averages.
• We have written in the past about the dispersion between the 10 largest companies and the other 490 members of the S&P 500. Sure enough, mean reversion has occurred. The largest companies: Apple, Microsoft, Amazon, Tesla, and Alphabet have all underperformed the S&P 500 index YTD. Value stocks have outperformed growth stocks dramatically, with value down just 11% and growth stocks losing 30%. This emphasizes the importance of a systematic rebalancing strategy. • After setting expectations a year ago that interest rates would not rise until early 2023, Jerome Powell and the Federal Reserve were forced to act quickly. They have now raised rates three times, most recently by 0.75%, the sharpest rate hike since 1994. Another 0.75% rate hike is possible in July.
• The average 30-year mortgage rate rose to 5.98% from 3.33% to start 2022. This has priced many buyers out of the market or left those with refinanced mortgages unwilling to move. Meanwhile, real estate listings have risen 18.7% from one year ago. The combination of increased supply and decreased demand are leading to dramatic price cuts as sellers rush to sell before their home values decline. Since data on home sales typically lag by three months, we will provide an update in our October newsletter.
• The Consumer Sentiment Index, which measures how Americans feel about the economy, hit a record low of 50.2. It is easy to understand why. However, seasoned investors will remember Warren Buffett’s “be fearful when others are greedy, and greedy with others are fearful” recommendation. The average twelve-month S&P 500 return after the Consumer Sentiment Index bottoms has been 24.9%. We will see if that holds true going forward.
• There are certainly signs that a recession could be on the horizon in the next year, with the June Purchasing Managers Index showing a larger-than-anticipated decline from 57.0 to 52.4. The services sector dropped from 53.4 to 51.6 with new business dropping 7.5 points- the largest decline since the onset of the pandemic. Note that measures of 50+ still indicate expansion, but now at slower rates.
• Nevertheless, markets price in all available data, meaning that an early 2023 recession is likely already priced into today’s markets. Long term investors should be looking to rebalance portfolios once again. Retirees, on the other hand, can now look to pick up yield from fixed income instruments for their short-term cash flow needs, something they have not been able to do for over a decade.
If you have any questions about your allocation and how recent events have affected your financial plan, please do not hesitate to reach out to your advisor.
Summer Financial Planning
The summer usually lends itself to more downtime and we hope you are finding time to relax with your families. With the absence of tax or end-of-year deadlines, the summer months can provide time to address areas that you have been avoiding up until now. Here are a few ideas before things pick back up in the 4th quarter:
• Review your estate planning documents if you have not already. Reach out to your advisor if you would like a referral to an estate planning attorney. And by all means do not store your Will in a safe deposit box!!!
• Review your power of attorney: does it line up with the trusted contact you have provided Schwab or Fidelity? If you do not remember who your trusted contact is, please do not hesitate to reach out to your advisor.
• Review your beneficiaries: are they up to date? Also, note that the SECURE Act changed how your heirs will have to handle Required Minimum Distributions. Previously, they could “stretch” their RMDs over their lifetimes. Now, those distributions generally must occur within 10 years of inheriting assets. If you have an heir that is in a high tax bracket, they will prefer to inherit your Roth IRA assets. On the other hand, a more moderate earner will pay less tax when inheriting your Traditional IRA.
• If retired, review your tax return and distribution plan to ensure you are withdrawing your assets in a tax efficient manner.
• Review your college savings goals with updated tuition figures.
• Review your life and disability insurance policies or employer benefits. Do these reflect your current income and needs? Would it make sense to cancel policies that you put in place years ago?
• Review your overall cash allocation. We typically recommend keeping 3-6 months’ worth of expenses in a checking/savings/liquid investment account. Thereafter, you may want to consider investing excess cash for long term goals.
• If you plan to make charitable contributions before 12/31, consider using appreciated assets and/or setting up donor advised fund for those assets. For those over 70 ½, consider making tax-free Qualified Charitable Contributions directly from your IRA!
If you have cash on the sidelines, we suggest considering I Bonds through TreasuryDirect.com. We sent out an email about how to do this back in mid-May. I Bond yields are currently 9.62% if you purchase through October. While they will reset lower if inflation comes down, the current annualized rate is more than 3 times higher than 10-year fixed Treasuries!
As always, if you would like to review your financial plan more broadly or have any questions about this report, please do not hesitate to reach out to your advisor.