A word about recessions.
Are we still going to see one this year?
Why did so many people think a recession was coming?
Inflation and interest rates, primarily. Historically high inflation has cast a pall over the economy since early 2021. In response, the Federal Reserve has raised interest rates rapidly to bring inflation back down. Analysts worried those rapid interest rate hikes could trigger a "hard landing" recession.
But it looks like the dark mood is lifting. You can see in the chart above that inflation has been on a definite downward trend since last summer. That trend suggests that the Fed's interest rate program has worked to tame inflation.
So, will the Fed keep raising interest rates?
Hard to say. The Fed raised interest rates again by a quarter of a point at its July meeting, but it's possible that it won't raise rates again if inflation remains on a downward trajectory. In fact, some analysts think that the Fed's next move might be to lower rates in 2024.
Does that mean a recession is definitely off the table?
That's far too optimistic. While the economy has been much, much more resilient than even seasoned analysts predicted, the accumulated effects of interest hikes may still deal a serious blow to growth. There are signs that the economy is weakening in some areas.
For example, while American consumers are still spending, they aren't buying as much stuff. That's hurting the manufacturing sector, which has been in a slump for a while. Since consumer spending is worth about 70% of economic activity in the U.S. it’s an important indicator for future economic growth. Employment trends will also be important to watch.
So far, the work of lowering inflation seems to have succeeded without damaging the job market. However, there are signs that the labor market may be weakening, so that's something to keep an eye on.
Bottom line: things seem to be looking up.
The dark clouds on the horizon appear to be breaking and there are reasons to be optimistic. But, it won't be smooth sailing. Is it ever?
I'm keeping an eye on trends and I'll reach out as needed. Questions? Don't hesitate to reach out, Brien@traditionswealthadvisors.com
Source: Life Strategy Financial. Munoz, Juan. 2 August 2023.
The number of fraud cases reported in 2022 was down year-over-year but the amount of money lost to scams was up—to $8.8 billion from $6.1 billion in 2021. The most prevalent scams were those dealing with investments. Imposter scams were the second most-common, followed by online shopping scams.
To help yourself stay safe, remember these guidelines:
One aspect of financial planning is considering the tax impacts of investment decisions. New rules for catch-up contributions, as shown in Anne Tergesen’s article, “High Earners to Lose A 401(k) Tax Break”, will change the tax impact for savers, especially those in higher tax brackets. Earners saving for retirement, ages 50 and over, are able to make additional contributions to their 401(k)s annually. Next year, these catch-up contributions must go into a Roth IRA account. The old rules allowed taxpayers to avoid paying taxes on these contributions at their current, higher tax rate and pay taxes on the earnings in retirement, when they will hopefully have lower tax rates. They could also take a deduction on these contributions. Now, the taxes must be paid upfront, and taxpayers lose this deduction. This means the contributions will be taxed at the earners current tax rate, not favorable for those in higher tax brackets, and they do not get tax saving in their current year.
However, there are benefits to this money being put into a Roth IRA. The biggest advantage is that any growth from the Roth IRA is tax-free. So, while this change may decrease tax savings in the current year, there would be no tax eating away at the realized Roth IRA investment in retirement. These changes are set for next year, but many have asked for delay to address some complications that these new rules pose. Some companies have to rework their systems to ensure the catch-up money in going into a Roth. Other companies did not previously have a Roth as an option for employees, which if unchanged, would cause those workers to forfeit any catch-up contributions. Companies are also unsure if under these new rules if they still need to ask permission to put this money into a Roth, or if it can be done automatically.
Time will tell the true impacts of these new rules, but it will certainly have an impact on strategic planning for retirement.
Questions on this article or to find out more, e-mail Brien@TraditionsWealthAdvisor.com or visit: https://www.wsj.com/articles/retirement-tax-breaks-401k-contributions-2868ffdc
You may still be breathing a sigh of relief about completing your taxes for 2022, and relishing the thought that you don't have to think about filing for many months to come. But with summer fast approaching, it's a great time to start lining up your strategy to help reduce your 2023 tax bill. Starting early can pay off when it's time to file next April.
Here are 6 tax-planning strategies to consider:
1. Examine your W-4 withholdings
2. Look for tax losses to harvest
3. Reconsider itemizing
4. Boost your pre-tax contributions
5. Plan for RMDs
6. Consider a Roth conversion
Everyone's tax situation is different, and it makes sense to consult with a tax expert or advisor to come up with a financial plan that works for you. With a little planning this summer, you can rest easy knowing that come tax time, you'll be prepared. For more information on each of these tax tips, click this link or contact us at Brien@TraditionsWealthAdvisors.com
The Fed raised rates as expected last week, and the broad consensus among investors and in the markets is that it was the last rate hike for this cycle. (The Fed itself didn’t commit to an end to rate hikes, but it did signal that pausing here is a very real possibility.)
While last week’s hike was broadly expected by markets—just as an end to the hikes at this point is broadly expected—what comes next is more of an open question. According to expectations priced into markets (which, granted, in fact are often wrong), the Fed will start a campaign of cutting rates, as shown below in the blue line. Given how high inflation still is, and how resilient the economy still seems to be, I think that may be wishful thinking.
Why does the market expect the Fed to imminently drop rates back to 3% or below? Perhaps it’s flawed modeling by bond traders. Or perhaps they are just using the average of all cycles. Historically, the Fed more often than not starts easing soon after its final rate hike. In fact, the forward interest-rate curve above looks almost identical to the average easing cycle that typically follows the peak of a rate-hike cycle.
How important is this disconnect? It may depend on where the economy, and inflation, go from here. If inflation continues to improve and the economy stays resilient, rates that are higher for longer could prove benign for markets. On the other hand, if inflation becomes stubborn and the economy weakens, then that disconnect could become significant.
Have rates gone high enough?In very simple terms, the Fed’s new 5% to 5.25% target range for the fed funds rate is the highest it’s been since 2007. But with inflation still elevated, are rates restrictive enough?
Based on my own calculations of what would be a “neutral” fed funds rate (meaning one that is neither restrictive nor accommodative), the Fed is moderately restrictive—with the current fed funds rate about 1 percentage point above neutral.
Another way of looking at it is by comparing the policy rate to the inflation rate. The Fed’s current target rate is now also above the 4.6% annual rate of change in the core Personal Consumption Expenditures Price Index (which measures price inflation felt by consumers, excluding food and energy, which tend to be more volatile). So by that definition the Fed is also moderately restrictive.
But based on the chart below, since the 1970s the Fed has generally raised rates to above the peak in headline inflation. So depending on which exact inflation measure one uses, by that standard the Fed may still be accommodative.
Some signs of a soft landingFirst-quarter earnings season is now heading toward the finish line, and the results have been strong. Out of the 425 companies that had reported by last week, 78% have beaten estimates—beating them by an average of 6.72 percentage points. It’s hard to see this earnings season as a glass half-empty.
The strength in earnings is supported by the fact that revenues continue to march to new highs (at least in nominal, or non-inflation-adjusted, terms).
And with revenues trending higher and earnings growth starting to flatten out, by definition it also means that profit margins are stabilizing.
Yet the market isn’t acting like a bull marketConsensus earnings estimates are suggesting that the US is headed for a soft landing. And this earnings season showed some encouraging signs.
But not all signs are pointing in the same direction. While the S&P® 500 is up more than 8% so far this year (and around double that since the market’s October low), there is uneven participation beneath the surface.
Early-cycle bull markets tend to be driven by segments and styles that are more economically sensitive and more volatile. Small- and microcap indexes are usually in or close to the lead in an early bull market—posting strong performance and usually beating larger-cap indexes like the S&P 500. But not this time.
Relative performance of Russell Microcap index to S&P 500 is taken by dividing the level of the Russell Microcap index by the level of the S&P 500 index. Source: FMRCo., Bloomberg, Haver.
The weakness in small caps and microcaps is not consistent with the idea that an early-cycle bull market is sprouting, and continues to cast at least some doubt on where we go from here.
That—along with expectations for the Fed—is among the key inconsistencies facing this moment in the markets, and why this still doesn’t look like the start of a new bull market.
Source: Fidelity Viewpoints. Timmer, Jurrien. 11 May 2023. https://www.fidelity.com/learning-center/trading-investing/interest-rates-peaked?ccsource=email_weekly_0511_1037578_43_0_CV1
The main factors that affected the market selloffs (a situation in which many investors sell their shares of a stock suddenly, often because of bad news) of equities and bonds during 2022 are still relevant today in 2023. These include high inflation, tightening monetary policy and higher interest rates, slowing U.S. and global economic growth, and geopolitical turmoil. However, it is how these factors evolve that will be critical to the 2023 outlook.
Top Things To Watch in 2023
Fidelity expects inflation rates to decline in 2023 but remain higher than what the market expects. Two key indicators to keep track of to determine when inflation may slow in 2023 are the housing and labor markets. Inflation peaked at above 9% in 2022 -the highest in four decades- the good news is inflation has decelerated to about 7% year-over-year in the second half of 2022 and is expected to be headed toward a further significant slowing in 2023. This has caused supply-chain disruptions to improve, energy prices to drop off their recent highs, and prices for most goods to come down late in 2022. The bad news is that financial markets have priced in a return to low and stable inflation quickly and painlessly, which many analysts and economists believe is not the case. The key to 2023’s outlook is the degree to which disinflation occurs in services industries, which often sees sticky inflation. A weakening housing market could help slow rental inflation rates in 2023. Labor markets will be a main focus for disinflation as well, where employee costs typically have had a heavy influence on the price of services. There have been signs of softening demand for labor, but aging demographics and other structural issues may continue to restrain labor supply and keep wage growth above levels compatible with 2% core inflation. The potential for stickier wages to continue supporting elevated labor costs means inflation could be more persistent than commonly believed. There would need to be a much larger weakness in the labor market and a significant increase in unemployment for the market’s low inflation forecasts to be correct.
Inflation trends are now headed in the right direction and the Fed may be in the final innings of its tightening cycle. Current market pricing indicates a belief that the Fed could stop hiking at around 5% by mid-2023 and possibly begin easing policy by the second half of the year. However, analysts at Fidelity do not expect inflation to come down as quickly as the market expects. They also believe that the fed will be willing to tolerate some economic pain through higher unemployment to make sure core inflation continues downward toward its 2% target.
U.S. Business Cycle
Leading indicators suggest that recession risks could continue to rise in the coming months. Credit conditions have deteriorated as lending standards at banks have tightened, the treasury bond yield curve remains inverted, inventories have risen as sales decreased, while new orders for manufacturing goods have also declined. Company profit margins have fallen, which is typical of the final months of the late-cycle phase. According to consensus estimates, the market expects positive earnings growth of about 3% in 2023. It’s possible that earning growth will hold up better than the 18% average decline during typical recessions, but Fidelity analysts think there is downside risk relative to market expectations.
Economists are also following employment markets and consumer spending in 2023 Consumers’ willingness to spend may be threatened by savings rates that have dropped to near all time lows, the apparent exhaustion of excess savings for low and some middle-income cohorts and falling asset prices. On the upside, labor markets appear structurally tighter and more supportive of medium-term wage growth. Additionally, household balance sheets remain in good shape, the increase of fixed-rate mortgage debt implies a lack of financial stress, and falling inflation may boost real (inflation-adjusted) income growth.
By the end of 2022, long term 10-year Treasury yields dropped well below the shorter term 3-month Treasury bills. This steep inversion of the current US Treasury bonds yield curve –with long term rates higher than short term rates– is historically a leading economic recession indicator and a sign that the financial markets believe that at some point in the future the Fed will have to start cutting rates in reaction to economic weakness. Economists are keeping track of business cycle indicators previously mentioned to monitor whether a U.S. recession becomes the dominant story of 2023.
Overall, Fidelity analysts believe that both inflation and policy rates could remain higher than current consensus investor expectations. The Fed’s latest inflation and interest-rate projections tend to agree, markets are overly optimistic at the moment. Uncertainty around these trends is likely to persist well into 2023, implying high odds of continued market volatility and heightened need for portfolio diversification.
However, this greater market volatility could provide even greater opportunities to purchase assets at discounted prices. Over the past 11 recessions since 1950, a diversified portfolio of stocks and bonds has returned an average of 6% and 11% over the one- and two-year periods after the start of a recession. Valuations are perhaps the most important indicator of expected returns over the medium and long term, and 2023 is a more attractive starting point for valuations than at any time in the past decade.
Consider these strategies to help counter fear of loss so you have the potential to grow your money. Fear of loss is a powerful motivator. But fear, like greed, is a dangerous sentiment for investors. Excessive fear of loss—which behavioral economists call loss aversion—causes many investors to act counterproductively. Fortunately, you don't have to treat growth and protection as mutually exclusive. Certain strategies can help you benefit from market gains, while protecting you on the downside.
No one has ever successfully and consistently predicted stock market returns. The strategy of jumping in and out of the market is known as market timing; investors who try to time the market typically sell after their investments have lost money, and buy only after stocks have recovered—selling low and buying high. Avoiding stocks altogether has major drawbacks too. Stocks provide the potential growth nearly every long-term investor needs to stay ahead of inflation. Cautious investors with long-term saving goals—those who will not need to access a portion of their assets for 5 to 10 years—may benefit from strategies that allow them to protect principal while exposing some of their assets to the stock market's growth potential. If you fit that description, consider the following strategies: the anchor strategy or the protected accumulation strategy.
1) Anchor strategy
An anchor strategy involves dividing your portfolio into 2 parts: a conservative anchor and more growth-oriented investments. The anchor portion of your portfolio uses investments that offer a fixed return, such as certificates of deposit (CDs) or single-premium deferred annuities (SPDAs). These assets have a set lifespan, and the amount you invest is designed to grow back with interest to your original principal. This portion of your portfolio acts as your anchor, while your remaining assets are invested in more volatile, growth-oriented securities such as stock mutual funds or ETFs. The anchor strategy can remove the negative outcomes cautious investors sometimes fear because even if the markets fall, your anchor makes sure you at least have what you started out with.
*Tip: Remember, inflation can erode the purchasing power of your original investment over time and this strategy generates taxes each year in a taxable account.
2) Protected accumulation strategy
Here's how it works: the protected accumulation strategy takes advantage of principal protection features on variable annuities. A guaranteed minimum accumulation benefit (GMAB) rider on an annuity is the most basic of these. Your assets are invested in a portfolio that typically has a larger equity position than the roughly 15% stake outlined in the anchor strategy above. For a fee, the GMAB rider guarantees that at the end of the annuity's investment period—typically 10 years—you'll have at least the same asset value you started with. Another potential benefit is that most GMAB riders let you reset the level of principal protection each year if your investments have grown in value. If you do lock in a higher balance, the investment period resets and your balance is guaranteed for another 10 years. It is possible that your fee may increase if you elect this option and annuity features will vary by the issuing company.
Which loss aversion strategy is right for you? Determining which, if either, strategy may make sense for you will depend on a number of factors, including your investing goal, interest rate environment, fees on your investments, your time horizon, and your tolerance for risk. First consider if you might be better off investing in a diversified portfolio, because either of these strategies (anchor or protected accumulation) may limit your upside growth potential—and the diversified portfolio may offer a greater long-term benefit. You also need to consider when you will need access to these assets, because both strategies might penalize early withdrawals.
Consider working with your financial professional to sort how to protect your principal while keeping a watchful eye on your overall goals, diversification of your portfolio, and exposure to taxes. Questions? Contact us at Brien@TraditionsWealthAdvisors.com
Source: Fidelity Viewpoints. 22 March 2023. https://www.fidelity.com/viewpoints/retirement/fighting-loss-aversion?ccsource=email_weekly_0330_1037579_36_0_CV2
The Fed’s Most Recent Rate Hike and Potential Future Rate Hikes
The Federal Reserve raised interest rates again by 0.25% for a Federal funds rate of 5.00%, the highest since 2006 right before the great financial crisis. A main paragraph from Powell’s press conference speech succinctly summarizes the Fed’s current outlook, “Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes. It is too soon to determine the extent of these effects and therefore too soon to tell how monetary policy should respond. As a result, we no longer state that we anticipate that ongoing rate increases will be appropriate to quell inflation; instead, we now anticipate that some additional policy firming may be appropriate. We will closely monitor incoming data and carefully assess the actual and expected effects of tighter credit conditions on economic activity, the labor market, and inflation, and our policy decisions will reflect that assessment.”
Jerome Powell’s statement is pretty straightforward, given recent major bank closures the Fed is likely to hike rates less than previously stated due to the economic results of the failed banks. Exactly how much less they are going to raise rates is difficult to pin down. It will depend on the depth and duration of the financial stress and the resulting sustained impact on financial conditions. Lastly, the upcoming Fed policy will be even more data dependent for both macroeconomic data and measures of financial conditions.
Mike Gapen and his analyst team at Bank of America have adjusted their Fed call. They are now predicting one more 0.25% hike in May and no longer a rate hike in June, however, they still don’t see the Fed beginning to cut rates until March 2024. This change to their call is due to the “tighter credit conditions” that Fed Chair Powell stated in his speech. Overall, they are expecting a Federal Funds rate of 5.25% to be reached in May. However, if stronger macroeconomic data comes in after May the Fed may be inclined to raise interest rates higher.
Bank of America Analysts also predict jobless claims to decrease to 190,000 from the previous 192,000. This underscores the tightness of the labor market and how much work the Fed still has to do to cool labor demand. They’re also expecting new home sales to cool to 650,000 at a seasonally adjusted annual rate for February, from 670,000 previously. Median prices of new homes have hit lows of $428,000 as of January, which was down for the first time on a year-over-year basis, at -0.7%. Nevertheless, the housing market remains tight as mortgage rates are still in high territory and months of supply have fallen steadily since September. New home sales should rebalance over time as supply adjusts to demand and mortgage rates cool down further.