retirement

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

Cloudy Inversions

In meteorology an inversion is a phenomenon where colder air is trapped below warmer air, often caused by clouds trapping the warmer air close to the ground while the upper levels of the atmosphere cool.  If you are in an area with hills or mountains and happen to be above the cloud level this can provide a beautiful view of peaks sticking out above the clouds.  But from a high vantage point you are unable to see what lies beneath the clouds.  You may also have heard about a yield curve inversion, but what does that mean and what does it tell us?  What lies beneath the clouds that we cannot see?

The yield curve is a graphical line showing current interest rates for various maturities with rates on the vertical axis and maturities extending out on the horizontal axis. Normally it has a positive slope, with rates moving higher as maturities are longer.  An “inversion” occurs when shorter term interest rates are higher than longer term interest rates. This can occur for varying maturities but is most often quoted as the difference in yields (or “spread”) between 2 year and 10 year U.S. Treasury Notes.  Interest rates are a measure of future risk so investors would expect to be compensated more, in the form of higher interest rates, for longer maturities since there is increased risk with holding a longer-term investment.  An inverted yield curve might indicate that there is just as much, if not more, risk in the shorter term.  What risks might this be foretelling? 

An inverted yield curve can often, but not always, signal a recession.  Historically when an inverted yield curve does signal a recession, it has been anywhere from two to six quarters prior to the recession starting, with the average being about one year. The magnitude and duration of a yield curve inversion are important and can provide an indication of the odds of a recession occurring and if so, how deep and prolonged the recession may be. The yield curve became minimally inverted at various times over the past two weeks but has only remained this way for a few days. This is not enough of a warning signal to say a recession is a certainty.  However, with inflation near 7% and short-term rates remaining close to zero we expect the Federal Reserve to raise short-term rates much higher so we could see a much deeper inversion, especially if longer term rates do not follow the same path higher.    

Reviewing past events, stocks tend to drop before a recession, but have positive performance during the recession and very strong performance after the recession as the economy recovers. It is important to remember the economy and stock market are not one and the same, with the stock market being a leading indicator and economic data being reported looking back.  We do not yet know if we are going to enter a recession but even if we do, there is a chance we have already experienced the corresponding pullback in the stock market.  If the current yield curve inversion foreshadows an upcoming recession, it may be several quarters in the future and in the meantime the stock market could perform well.          

Looking Back

The first quarter of 2022 is now behind us, so it is worth taking a look back to review what occurred.  Most global stock market indices ended the quarter lower, the first quarterly losses since 2020, with the S&P 500 ending the quarter down 5%, the Dow off 4.6% and the Nasdaq losing about 9%. All were even lower a few weeks prior, but the markets surged since the Federal Reserve only raised interest rates by one quarter of a percent at their March meeting.  While the major indices reached their low points in early March, many individual stocks reached their low points in late January or mid-February and are continuing to show strength. 

The bond market did not do much better with bond prices falling as interest rates rose.  The most widely followed bond index, the Bloomberg Barclays Aggregate Bond Index, dropped nearly 6% on the quarter.  As we discussed last week, the traditional “60/40” portfolio consisting of 60% equities and 40% fixed income has not fared well, nor do we expect it to for at least the next two years since interest rates are expected to continue to rise.  Commodities performed well as prices spiked from concerns about diminished world supplies resulting from the Ukraine situation.  Prior to the events in Ukraine, the stock market was already headed lower, which was attributed to stock valuations well above historical norms, especially technology stocks, and anxiety over Federal Reserve action to combat inflation.  The Ukraine situation further increased volatility and selling pressure, at least in the short term, but the focus now remains on further Fed action and interest rates.

Looking Ahead

As we embark on the second quarter of the year, many clouds hang over the market especially inflation and the Ukraine situation.  The latter’s effect on the markets is most likely diminishing with markets most likely to be affected by interest rates and inflation. We are also seeing a decrease in consumer sentiment.  With higher levels of inflation, especially for food and energy, consumers are less likely to spend money on discretionary items.  A major pullback in consumer spending will undoubtedly dampen economic growth so we are keeping a close watch on this and do not expect consumer sentiment to improve until inflationary pressures abate.   We also continue to watch the yield curve to determine if the inversion becomes deeper and is truly signaling an impending recession.  Even if it is, this does not necessarily mean the stock market is going to drop further. 

Every recession is different and caused by varying factors and while we can use history as a guide, it is not a way to predict the future. Whether we end up in a recession or not is somewhat inconsequential to investors since the stock market, while effected by the economy, moves independently.  If you are worried about what is beneath the clouds that you cannot see and how it may impact your retirement, please give us a call to ensure you have a solid plan in place to weather whatever lies ahead. 

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

The Odd Couple

A common theme in movies are the relationships between key characters.  Sometimes these relationships can be challenging as was illustrated numerous times on-screen between Jack Lemmon and Walter Mathau, who happened to be very good friends off-screen.  The two actors are perhaps best known for their clashing roles in “The Odd Couple” and of course local favorite “Grumpy Old Men.”  (The latter of which was meant to be a comedy but may be viewed as a satirical documentary in this part of the country.)  In these movies, there are differences between their characters which were not always complimentary and would at times be adversarial.  The relationships between asset classes can be similar – they may be in contradiction to each other, which is good for diversification, but this does not always happen and we should be aware they can, and do, change over time.    

Conventional wisdom over the past three or four decades has been to hold a mixture of stocks and bonds in your portfolio with the thought being that if stock prices fall, bond prices will rise to cushion the impact.  A quick reminder that the relationship between bond prices and yields is an inverse one; meaning if yields fall, prices go up and vice versa.  Prior to the beginning of this year, bond yields have, for the most part, fallen over the past three or four decades, giving rise to bond prices.  Now that we are faced with the highest levels of inflation in 40 years, we are experiencing a fast rise in bond yields, which we expect to continue for at least the next year.  So far in 2022, we have seen the fallacy of having a portfolio consisting only of stocks and bonds – both have dropped in value.  If you are a retiree drawing upon your investment portfolio, this means you have had to withdraw money when the market is lower, which comes at the expense of future growth, made worse when the loss of compounding is included. 

Historical data indicates that bonds tend not to fluctuate as much as stock prices because interest rates generally do not move very quickly.  This year seems to be an exception as there has been a fast rise in interest rates with the Federal Reserve taking action to fight growing inflation. Most bond portfolios have lost money year-to-date with the widely followed Bloomberg Barclays Aggregate Bond Index being lower by about 7%.  Benchmarks tracking longer duration bonds are down double digits.  So much for bonds being a “safe haven,” especially when you figure in the effects of inflation.    

Confusing Times

Despite positive returns last week for the major stock market indices, marking the first time this year they have had consecutive weeks of positive returns, they remain lower year-to-date.    Energy has performed strongly, but that is an exception as many industries have performed quite poorly.  Had you invested only in energy stocks at the beginning of the year, or sometime during the last half of 2021, you would be doing very well but that lack of diversification is not prudent investment management. When the pandemic hit in 2020 and oil prices dropped to literally zero, most energy stocks lost at least two-thirds of their value.  We’ve recently seen many high-growth technology stocks retreat some 50% or more, and in some cases 75%, from their highs.  Many of these stocks have rebounded slightly over the past two weeks but if you lose 50% of your value, you need to make 100% to get back to break-even so even these rebounds are not nearly enough with many stocks remaining well below their all-time highs.  Further evidence of the importance of diversification between asset classes and sectors.  For the first time in a long time another asset class, commodities, are having their day in the sun, but this may be nearing a tipping point.  Demand may drop if prices rise much further, putting pressure on prices; we most likely have reached an equilibrium point and will see most commodities, such as oil, trade in a range for the time being. 

The stock market seems to be creeping upwards after hitting a bottom, at least in the short-term, on March 14^th.  With inflation now “raging” (a term used by one of the Federal Reserve Governors), interest rates rocketing higher, and the possibility of us being on the precipice of World War III it is rather surprising the most market indices are only down 5%.  Perhaps this is telling us something. The stock market is considered to be a leading indicator and recent moves suggest that things are not that bad and despite world events the economy remains strong.          

Looking Ahead

More than one Federal Reserve Governor, including Chairman Jerome Powell, have publicly acknowledged the Fed is behind the curve fighting inflation and a half-point rate increase is certainly on the table during the next Fed meeting in May.  According to FactSet, bond market futures are giving a half-point rate increase at the next Fed meeting an 85% probability but this should be taken with a small grain of salt since it is known the futures markets can move quickly and are very dependent upon data and events. 

This coming week marks the end of the quarter, one which many investors would like to forget since it has been a rather rough start to the year.  As mentioned above, the market is starting to show some resilience and many times in history the stock markets hit their low points in March and then quickly rebounded eventually ending with positive gains for the year.  2003, 2009, and 2020 come to mind as examples.  Please give us a call if you would like to review your portfolio to make sure you are best positioned for the changing relationships between asset classes.  There are multiple options for keeping your hard-earned money safe while keeping pace with inflation. We would be glad to discuss how these might work for your individual situation.      

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