Tax Planning

A.I. and the Magnificent Seven

As we pass the midway point of 2023, we would like to share our perspectives on what occurred in the markets in the first half of the year as well as share our outlook for the last half (and beyond).  The prospect of lower interest rates and continued economic growth, thanks to continued robust consumer spending, provided support to the markets. Also contributing to the strength was government backing of the beleaguered banking system, injecting further liquidity into the economy and helping prop up markets during a tumultuous time.  Equity markets rebounded strongly from the challenges experienced in 2022.  The Nasdaq had the best first half of a year in its history, climbing 39%, while the S&P 500 gained 16%.  Gains were primarily driven by a small handful of stocks (a.k.a. “The Magnificent Seven”) – Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla.  Much of the force behind the moves higher was based upon speculation on the prospects of Artificial Intelligence (“A.I.”).  The strong outperformance of these seven stocks propelled indices higher since collectively they now comprise well over one-quarter of the S&P 500 Index. It was not until June that the other sectors of the market began to play catch-up and also participate in the gains.  A stock portfolio not owning these particular names, especially in such large relative amounts, would have significantly underperformed the indices. This also led to many active strategies underperforming passive strategies.  It is for this very reason this reverse could occur in the second half of the year; if these stocks underperform the broader market, actively managed strategies will outperform. 

Many of this year’s best performers are now trading at high, but not necessarily absurd, valuations above historical averages.  From a fundamental analysis perspective, it would be difficult to justify purchasing certain stocks at these levels since these valuations seem stretched even if the most optimistic projections do come to fruition.  In some ways, the current environment is slightly reminiscent of the dot-com bubble of the late 1990s, in which former Fed Chairman Alan Greenspan referred to escalated asset values as being “irrational exuberance.”  When it comes to investing, timing can be everything.  Greenspan’s comments were eventually proven to be correct, however asset prices did not fall until more than three years later and in the meantime, gains in the stock market were plentiful.  Today, momentum continues to drive markets, especially the aforementioned stocks, and momentum, either positive or negative, is difficult to stop or reverse. 

 Inflation and the Fed

Inflation has been slowly decelerating but remains persistent and above the Fed’s stated comfort zone. After a series of 11 consecutive interest rate hikes the Federal Reserve decided to pause in June and keep rates steady, however they have indicated they anticipate raising rates at least two more times this year. Even though they are signaling future hikes, the Fed does appear to be nearing the end of the current rate hike cycle.  We could see a pattern of single quarter-point rate hikes followed by pauses to allow the Fed to assess monetary policy lag until they deem the job is finished and inflation is fully under control.  When the Fed does decide to fully stop, it seems likely interest rates will be held “higher for longer” and will take some time before being lowered.  One concern is that inflation, as measured by the government, could again accelerate, spurring further Fed action.  Data shows that inflation peaked in June of last year with subsequent months showing continuously lower levels of year-over-year price changes.  Now that the high readings of 2022 are more than a year in the past, future readings will be compared to 12 months prior when inflation was more subdued, increasing the probability of higher readings. Conversely, a worse than expected recession could spur the Fed to lower rates sooner than expected, but this is not an ideal scenario and would coincide with markets reacting unfavorably to economic data.  If a recession is avoided in the short term and employment remains robust, which it has thus far, the Fed will see no reason to stop the current campaign.  It should be noted that unemployment tends to trough, or reach its low point, at or near the beginning of a recession and then as the recession takes hold, jobs are cut, causing unemployment to spike.  Unemployment continues to sit near multi-decade lows, so any inference that we are not in a recession because of the strength of the labor market is a faulty argument. 

Soft Landing or Recession???

In addition to interest rates, corporate earnings are the other main factor driving the stock market over the long-term.  Earnings are expected to drop compared to a year ago as inflation continues to pressure margins.  We may already be in the midst of an earnings recession (not to be confused with an economic recession).  According to FactSet, the S&P 500 is expected to show a year-over-year earnings decline of 6.8% for the second quarter of 2023. Interestingly, earnings per share estimates declined during the quarter while the S&P 500 Index rose.  Increased probabilities of a soft landing coupled with the prospect of lower interest rates overcame lowered earnings expectations to push markets higher.  This may not be the case going forward; lowered earnings coupled with higher interest rates could become a major headwind for the markets and derail the recovery. 

Just about every Wall Street analyst has predicted a recession over the past year, but we have yet to see one. Are these analysts being too pessimistic or has the timing been off?  One school of economic thought is that the supply of money is a clear cause of inflation.  During the COVID pandemic we experienced the largest-ever expansion of the money supply through government stimulus programs and very loose monetary policy from the Fed. The stimulus payments have driven strong consumer spending, helping to prop up the economy over the past two years. When the stimulus money runs out, spending will return to normal levels and no longer provide as much support for economic growth.  More recently, higher interest rates and tighter bank lending standards have shown signs of reducing the money supply and historically contractions in money supply lead to a recession.  However, this seemingly has been the most anticipated and predicted recession of all-time so perhaps the bad news has already been priced into the stock market.

Looking Ahead

If you have been invested in the stock market you have most likely enjoyed rather robust gains this year, but you missed out if you are sitting on the sidelines.  We would recommend not trying to chase the current trends as it may be too late, but instead look at investing in a well-diversified portfolio.  We do not necessarily think a pullback is imminent, but rather see a slowdown with the “easy money” having already been made and gains being more difficult to achieve going forward. We expect returns to be more muted in the second half of the year. While we might sound pessimistic, we do not expect a major downturn but more of a levelling off in the market and do remain optimistic regarding certain sectors and strategies.  With the prospect of more muted gains, dividends could play a larger role in overall returns.  This is a good time to consider other investment alternatives and look beyond the traditional stock/bond portfolio.  Given the outlook for more modest market returns and further market volatility, it may be wise to consider protection strategies.  Many of these strategies provide potential for growth or income should the markets continue to rally but there is also downside protection should they fall. Risks certainly exist, as they always do, which have the potential to drive markets lower.  It is also a good time to remind ourselves that markets do not always behave logically and rationally. 

Despite what happens in the second half of the year and whether our outlook proves accurate or not, we would like to remind everyone that investing is a long-term proposition.  You should only invest money you do not plan on spending in the short term so you can ride out market fluctuations over longer periods of time.  Looking forward, we see challenges with returns possibly being less than we have experienced in recent memory while inflation remains persistent, chipping away at purchasing power. 

While both optimistic and pessimistic investors are due to be right often enough to boost an ego, at least in the short-term, we feel a better approach may be to focus less on the funds invested for long-term wealth accumulation, and more on a comprehensive plan built around a spend in confidence, pay taxes consciously approach, we feel you will be rewarded with a comfortable retirement.  We will continue to monitor the markets as we always do, making changes in portfolios when warranted, but we view our primary role for our clients being to ensure that the wealth accumulation from investment markets supports a well-designed retirement plan.  To discuss your individual situation or learn more about some of the strategies we are currently implement do not hesitate to contact us.  Our goal is to help guide you towards a Secured Retirement, regardless of what the next six months of 2023 provide in the financial markets. 

We hope you are having a great summer!

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

Summer Camp

In the summertime parents often send their children off to camp which generally is somewhere in a forest often near a body of water.  For parents it gives them a reprieve from having to keep their children occupied while not in school and for the children it is an opportunity to hang out with others their age as well as take part in outdoor activities.  While certainly not a restful vacation, camp tends to be a quiet time over the summer and a break from the normal routine.  The markets seem to be slowing down and taking a bit of a break, leaving us to wonder if this will continue for the remainder of the summer or if it will be short lived.

Last week the major indices finished lower with the S&P 500 breaking a five-week winning streak and the Nasdaq an eight-week streak.  There was not a main driver of the slight pullback with many analysts attributing it to the possibility the stocks which have recently enjoyed abnormally large gains perhaps are overextended or at least need to take a breather.  Otherwise, there were few changes to the broader themes that have been recently discussed.  During an appearance on Capitol Hill, Federal Reserve Chair Jerome Powell reiterated that two additional rate hikes are “a good guess” if the economy continues to perform as expected. This is in-line with comments made the prior week and the recently released Fed “dot-plot.”

The markets have been led higher this year by a small group of stocks with outsized gains, most of which have been associated with the artificial intelligence (A.I.) craze.  Reviewing valuation metrics of the stock market, the valuations of hyper growth stocks has fallen considerably from two years ago but remain elevated above long-term averages.  The recent market run-up has made them more expensive, especially on a relative basis compared to other sectors and higher quality stocks.  But as we’ve often seen in the past just because a stock or sector is cheaper does not necessarily guarantee it will perform better going forward.  We remain cautiously optimistic on the markets for the second half but think strength will come from different sectors and names than we saw in the first half.    

Campfire Songs

While at camp, once the sun goes down and it gets dark the children may gather around a campfire to sing songs and tell stories.  The songs tend to be of good nature and often elicit laughs while the stories may be of the scarier variety, often of a dreaded creature emerging from the darkness of the forest in which the campers are gathered.  What types of scary creatures could emerge from the darkness to derail your retirement?

There are always unanticipated threats such as war, natural disasters, pandemics, just to name a few, but we also try to think about the more common occurrences which could negatively impact the markets.  With the Fed seemingly winding down, the threat of higher interest rates seems to be abating but are we being lulled into a false sense of security?  Will inflation continue to abate and eventually fall to a level comfortable for the Fed as well as the general public where it does not inhibit economic growth?  It seems to be slowly headed this direction, but still has a long way to go. And while no longer near the multi-decade highs in inflation we were experiencing a year ago, increases in prices continue to lead to an erosion of purchasing power.  Even if inflation remains in the 4-5% range, this will erode purchasing power considerably faster than if inflation were around 1-2% so obviously should not be overlooked in your retirement planning. 

We also remain focused on corporate profits, which is the largest driver of stock market returns over the long term.  As of March, earnings expectations for the S&P 500 had been lowered by 12% from the prior year, leading to more positive earnings surprises from the first quarter than expected, providing a tailwind for the markets.  Since then, Wall Street analysts have increased their earnings estimates 2-3% for the next twelve months.  The change in sentiment, while not large but if proven accurate, does give stocks a firm foundation to climb.   On the other hand, with increased expectations comes increased risk they are not met, providing a headwind for the markets.  Historically, positive earnings surprises have averaged 4-5% of the companies in the S&P 500 in any quarter.  The first quarter of this year, nearly 7% of companies beat expectations, much better than the less than 1% that did in the fourth quarter of last year. 

Looking Ahead

This is the last week of this quarter and will end a positive first half of the year, exceeding most expectations and predictions.  The threat of a recession continues to loom large, especially as the yield curve remains inverted with the negative yield spread between 2-year and 10-year Treasury bonds around a full one percent, which is significant by historical standards.  In the past an inverted yield curve has been a strong recession predictor, with a lag of 12 – 18 months.  For reference, the 2-year/10-year inversion began in July of last year and if history is any indication, we very well could see a recession in the second half of the year.  But since a recession has been so widely anticipated for so long, it may not have much impact on the stock market since it may already be priced in.

We will continue to watch inflation and further action from the Federal Reserve.  A quarter-point hike at their next meeting in July is expected. The Personal Consumption Expenditures (PCE) inflation report this week will give ore clarity but since a major move is not anticipated it seems unlikely to derail the Fed.  Even though it is summer and market activity seems to be slowing, we continue to remain vigilant and watch the markets so you can spend time at camp, on vacation or at your cabin.  We are here to help you feel confident in your retirement, despite what might be lurking in the darkness. 

Have a wonderful 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

Old Westerns

Western films, which depicted life in the American West and the new frontier in the late part of the 19^th century, reached their pinnacle of popularity between the mid-1940s and mid-1960s.  In most of the films, a hero came up against a villain with the scene being a gunfight or stand-off taking place in the middle of a frontier town where each was staring at the other, waiting to make a move, with tense music playing in the background.  The Fed has been in an ongoing fight with inflation, which now seems to have reached a point where they are staring each other down waiting for the next move before taking further action. 

The Fed held interest rates steady last week, but in post meeting comments emphasized this was merely a pause (or a “skip”) and not necessarily the end of the interest rate hiking cycle.  They also released updated economic forecasts in their quarterly Summary of Economic projections, including its “dot-plot” which indicates where Fed members expect interest rates to be in the future.  This forecast indicated that Fed members expect two more rate hikes before the end of this year, higher than projections made in March and a contradiction of previous market expectations of a drop in rates by year-end.    Projections also showed expectations for inflation peaking higher than previously anticipated. 

The monthly Consumer Price Index (CPI) inflation report last week showed that headline inflation cooled to 4% with core-inflation (excluding food and energy) remaining “sticky” at 5.3%.  A large driver in the headline number was a pullback in energy prices, which tend to be volatile especially on a month-to-month basis.  The Fed Funds rate is now equal to the inflation rate for the first time this cycle. Historically the Fed has never lowered rates while the Fed Funds rate is below the inflation rate, so it is little surprise the Fed has not considered lowering rates thus far.  Year-over-year inflation peaked in June of last year so inflation readings for the remainder of this year could be interesting since they are a comparison to 12 months prior.  It seems CPI is on a downward trajectory and if it continues, the Fed has been successful reigning in inflation while achieving a soft landing in the economy; a feat that looked extremely unlikely a year ago.  But that being said, some economic indicators are showing a slowdown, so it remains to be seen if we are truly able to avoid a recession. 

The Magnificent Seven

Considered one of the greatest films of the Western genre, the Magnificent Seven tells the story of how seven gunfighters are hired to protect a small Mexican village from a group of marauding bandits.  We’ve seen something similar emerge in the stock market this year with a septet of big tech firms driving markets higher while the remainder of the market has contributed little to this year’s market gains.  In the 1970s there was the Nifty Fifty, the late 90’s brought the “Four Horsemen” and more recently there were the FAANGs (Facebook, Apple, Amazon, Netflix, Google) which has morphed into the newly coined “Magnificent Seven” consisting of the same companies, minus Netflix, with the addition of Microsoft, Tesla and Wall Street’s latest darling, Nvidia.  These stocks have helped propel the S&P 500 into a new bull market, being up some 26% from its low last October.  However, it still remains 8% below it’s all-time high reached in November, 2021.  Some other names have performed well, but the rally has not been as broad based as the index performance would indicate. 

Markets rallied last week on the heels of the Fed pause and enjoyed their best week in over three months.  There appears to again be positive momentum in the markets.  However, we remain cautious on some of the names mentioned above as they perhaps have gotten ahead of themselves with valuations well above historical averages. Current stock prices are factoring significant growth which seems overly optimistic in our view.  We remain more positive on the remainder of the market as we see signs of a rebound in the making.  This is especially true of small cap stocks which seem to be enjoying a recent resurgence. 

Looking Ahead

As we near the end of the first-half of the year we can reflect on what has occurred and look ahead to what the second half might bring.  Despite overwhelming expectations and forecasts of a recession, this year has brought a welcome surprise in the equity markets. Overly cautious investors and those trying to time the market have missed out. That is not to say the market will not dip in the future, which it undoubtedly will at some point as it goes through its usual gyrations, but this again is evidence that predictions, both positive and negative, from even the most well-regarded “experts” are often not realized when it comes to investing.  There are two full weeks remaining in the quarter, but it seems the market has positive momentum heading into the second half of the year.  We will be watching the usual economic indicators but have an especially keen eye on inflation and earnings. The biggest risk we see to the markets in the second half is an earnings recession. 

Even if the Fed does not take additional action, monetary policy remains tight since interest rates are much higher than they were just 18 months ago.  We remain constructive yet cautious, on the equity markets and while fixed income instruments are producing the highest yields seen in 15 years, they are still subject to fluctuations in prices from swings in interest rates, giving us reason to pause in the current environment.  For those worried about what the equity markets might bring, our preference is for other types of protection strategies.  If you are staring down your retirement and trying to decide the next move, let us help you make the right move to win the fight. 

Have a wonderful 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

Crisis Averted

Action movies, especially those from earlier decades, often show a cataclysmic incident about to take place, only to be stopped at the last moment by the hero. These events sometimes border on the edge of preposterous and they often depict events that might greatly affect a large population, entire countries, or even the entire world order. In most action movies we know the good guys (or gals) come out on top, but we still feel tension and angst as we watch events unfold and near an actual crisis.  Last week an agreement was reached on the debt ceiling and the media headlines called it a crisis averted, but in reality how close were we to a real crisis? Would the U.S. have defaulted on its debt, possibly sending financial markets into chaos? 

The media hyped up the possibility of a default but in reality this was most likely just political theater by both parties since it would be in neither best interests to not reach an agreement.  Even though it was not a surprise, the markets cheered the agreement and enjoyed a strong rally on Friday to cap off a positive week with the Dow, S&P 500, and Nasdaq all ending with weekly gains of about 2%.  The small-cap Russell 2000, which recently had been negative on the year, performed even better with a gain of more than 3%.  Friday’s rally was very broad based and included all sectors; a deviation from recent event where market returns have been predominantly driven by strength in the technology sector.  On a year-to-date basis the Dow is up 2%, the S&P 500 has gained nearly 12%, and the tech-heavy Nasdaq is higher by a whopping 26%.  Despite this rebound, the Nasdaq still sits some 17% off the all-time high reached in November, 2021 while the Dow and S&P are 7% and 10% off their highs, respectively.  The same is true of many mutual funds and ETFs – some of this year’s highflyers were last years poorest performers and still have not recovered.  This is a reminder of why protecting against downside risk is so important.  When it comes to investing, slow and steady often wins the race. 

Job Well Done

Monthly employment reports helped contribute to the market rally on Friday.  The number of new jobs created was substantially higher than expected while the unemployment rate jumped considerably more than expected.  The labor market seemingly remains robust with solid job growth but the uptick in the unemployment rate indicates that some weakness may be appearing.  Given the conflicting data, analysts are split on the implications for the Federal Reserve at their upcoming meeting.  Recent speeches from Fed officials had alluded toward another rate hike next week.  Further fanning speculation of another rate hike was the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, surprising to the upside with a rise of 4.4% compared to a year ago.  This was an acceleration from the 4.2% annual rate reported the previous month.  This measure of inflation has fallen significantly since its recent high of 7% last June, but the fact this report did show an increase in year-over-year inflation from the previous month is likely somewhat concerning to the Fed, especially since it remains above the Fed’s target of 2% and shows that inflation not only remains persistent but also is deeply embedded. 

As of now, it is unknown what action the Fed will take at their meeting next week, but what is certain is that a pause does not necessarily mean an end to the rate hikes. The Fed could simply pause to further assess economic conditions and then continue on their upward path.  Markets are pricing in another quarter point rate hike in July and the market pricing for the December fed funds rate suggests there will not be any rate cuts by year-end.  Regardless of what happens in coming weeks, it does seem we are nearing the end of the rate hike cycle, and given what has recently occurred with Treasury yields, we have probably already seen the peak in most interest rates. If you are waiting for higher rates or only investing in very short-term rates you might want to reconsider and lock in current interest rates for a little longer term. 

Looking Ahead

This coming week will be very quiet in terms of economic releases and will be the “calm before the storm” with CPI, PPI and the Fed meeting the following week.  Investors will be waiting to see if there will be follow-through to the surprise rally on Friday.  Last week saw the biggest money inflow into technology stocks on record.  These inflows, especially if continued, could provide some momentum going forward.  Or if you are a contrarian, this might mean we have seen the short-term peak and it would be a good time to trim back.  The recent Artificial Intelligence (A.I.) buzz in the markets has helped propel certain names higher but it does give question to how much higher these stocks can go in the short-term. The size of the A.I. market remains to be seen and over the longer-term would appear to be enormous, but one can’t help but think that maybe there is a bit of a bubble or mania in these stocks.  This is probably not a time to be getting too greedy. 

Long-time market advice about being a long-term investor and not trying to time the market has been reaffirmed with the recent rally. Those waiting on the sidelines have missed out but fortunately are most likely earning decent interest in cash or other short-term instruments for the first time in over 15 years.  With a slowdown in economic indicators, it may seem the long-predicted recession could eventually come to fruition but there is also a likelihood that the worst of the market is in the rearview mirror.  For those sitting in cash, there are still plenty of opportunities, but time might be running out.  Avert your own crisis by planning ahead and having a solid long-term plan in place to ensure you feel secure in your retirement.

Have a wonderful 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 Brickyard

The 107^th annual Indianapolis 500 will be run this Sunday at Indianapolis Motor Speedway, which is nicknamed the “Brickyard” since the racing surface was originally paved in brick.  Today the surface is paved over with asphalt, except for a distinct three-foot-wide line of bricks at the start-finish line. Average speeds over the entire 500-mile race tend to come in just shy of 200 m.p.h., making it one of the fastest spectator events in the world.  This is a sharp contrast to the recent speed of events in the economy.  Arguably the most anticipated recession in recent history still has not taken place, seemingly moving at a very slow speed and continuing to keep markets on edge.

The major stock market indices closed higher last week with the Nasdaq and S&P 500 having their best week since March and highest weekly close since August of last year.  Big tech continues to lead the way with the usual suspects (Apple, Alphabet, Microsoft, etc.) all finishing at their highest levels in at least a year.  Stocks moved higher throughout the week as debt ceiling negotiations appeared to be making progress in Washington, however both sides stepped away on Friday saying a “pause” was needed after talks hit an impasse.  The major sticking point seems to be the size of discretionary spending caps.  While there are continued signs of reluctance from both sides to negotiations and compromise, we remain optimistic an agreement will be reached and a default avoided since it remains in neither party’s best interest to let one occur.  Good news on the negotiations front helps provide some thrust for the markets but we think it will be relatively short-lived and the markets will return to trading on fundamentals of the economy and corporate earnings.

The first quarter earnings season is drawing to a close and the profits of S&P 500 companies are estimated to have dropped almost 4% on average. Data compiled by Bloomberg shows that 78% of firms surpassed forecasts, but that is less impressive than it sounds knowing that analysts have lowered estimates.  While we may (or may not) be teetering on the brink of an economic recession, a recession in earnings is likely already upon us. 

Gasoline Alley

The garage area at Indianapolis Motor Speedway is known as “Gasoline Alley” since that is where cars would refuel during the early days of the race.   As a side note, gasoline was phased out in favor of methanol beginning in 1965 and since 2006 ethanol is the fuel used to power the racecars.  Since everything seems to have a name at the Speedway, we would be remiss if we did not mention the “Snake Pit” which is the infield of the track where spectators often go on race day but has a reputation for rowdiness and disorderly conduct.  When it comes to investing, there are probably times you might feel that your portfolio might need a trip to the garage for a “tune-up” and it might also seem that the markets undergo their own periods of rowdiness. 

Last year could be considered a “rowdy” year in the markets with plenty of volatility and large losses across almost all asset classes.  This year has been tamer in comparison with the stock market slowly melting upwards and bonds providing positive returns as interest rates have pulled back.  Much of the reason for the melt-up in the stock market is the widely forecasted recession has yet to materialize, with some wondering if it ever will.  The move higher in the markets is also attributable to the strong performance of the biggest names in the S&P 500 index, primarily big tech as we mentioned before, with the remainder of the index being nearly flat.  While the tech-heavy Nasdaq is higher by double digits, the Dow Jones Industrial Average and Russell 2000 small cap index are both barely positive on the year, so the rally has not been widespread and is in fact concentrated in a small number of very large names.  Since lower interest rates lead to a larger current value of future earnings, the biggest benefactor of the recent pullback in rates has been high growth companies.

Investors remain on edge wondering what the next moves are for the Federal Reserve.  Anticipation of a pivot from the Fed, reversing course and beginning to lower interest rates, has been a tailwind for the stock market this year but the market has not always been correct when it comes to foreshadowing Fed moves.  A few short weeks ago futures markets were pricing in about a zero percent chance of a rate hike at the Fed’s next meeting in June, but now that has increased to 25% so some intrigue remains into the Fed’s next move. 

Looking Ahead

First quarter earnings season winds down this week but there are still notable names to report including some major retailers which will provide further signs about the health of consumers.  Reports last week from Wal-Mart and Target indicated that spending is slowing and consumers are more price conscious.  Debt ceiling negotiations will continue and could provide some volatility on a daily basis, but as mentioned earlier, barring the scenario where an agreement is not reached, this probably will not have a significant longer-term impact on the markets.  There are also several economic releases this week which will provide indications on the health of the economy, with perhaps the most notable being the Fed’s preferred inflation gauge: the Personal Consumption Expenditures (PCE) Price Index.  Current odds are showing the Fed will pause interest rate hikes at their next meeting but another elevated reading of PCE with no signs of significantly subsiding may be enough to push the Fed to raise rates another quarter point. 

This week is the last full week in May and often is the case where markets are quieter over the summer.  Should you “sell in May and go away?”  We remain long term investors and do not advocate for trying to time the market, but there is little on the horizon that makes us think the market is going to make a large move in coming months.  However, it is not worth the risk of not being invested and waiting for the right opportunity should a catalyst occur that sends markets soaring.  As we have been discussing, many people are waiting for a recession, which may not occur, and if economic conditions improve considerably the markets are likely to move higher quickly. 

Car racing is very fast but takes a considerable amount of preparation and one small error while on the racetrack can have a catastrophic effect. Both can also be said for retirement planning- it also takes a great deal of planning and can easily be derailed.  Be certain you feel safe in your retirement and do not need to spend it under the caution flag.  We would be glad to discuss your situation and help ensure you make it to the winner’s circle. 

Have a wonderful 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

Into Thin Air

Last week marked the solemn anniversary of one of the most notorious mountain climbing tragedies in history when eight people lost their lives on Mount Everest in 1996.  Books have been written chronicling the tragedy with perhaps the best-known being Jon Krakauer’s Into Thin Air.  Various causes led to the deaths of those who perished, but they all had one thing in common – they were on the descent, not the ascent.  This is a reminder that climbing to the peak of a mountain can be very challenging, but it can be just as difficult to get back down off mountain. Retirement can be very much the same: saving for retirement during your working years is similar to scaling a mountain but is generally only half the battle. Challenges lie in replacing your paycheck in retirement by converting that savings into income while avoiding obstacles, such as paying too much in taxes.  

Equity markets were mostly lower last week with the major economic event being the release of the Consumer Price Index (CPI), which showed inflation pressures remain elevated but continue to slowly decline.  Headline inflation rose 4.9% over the prior year which was in-line with expectations and a slight decrease from the prior month’s 5% annual increase.  Headline CPI has dropped considerably from its peak last June when it hit 9%, however the rate of deceleration has slowed with the latest reading being nearly unchanged from the prior month.  The largest contributors to this inflation reading were shelter and food costs.  Price changes of other goods have moderated with energy components showing declines compared to a year ago. Core CPI, which excludes food and energy, was higher by 5.5%, changing little since December and remaining not too far off its recent peak of 6.6% last September.  The Producer Price Index (PPI), a measure of goods produced, came in much lower at 2.4%.  This is dramatically lower than its peak of 11.6% from March of last year.  Prices of goods are stabilizing but the cost of housing and services continue to rise causing overall consumer inflation to remain elevated and “sticky.”

The implications of this inflation report are that inflation remains elevated and above the Federal Reserve’s comfort zone but since it is declining, albeit rather slowly, the Fed is now expected to pause interest rate hikes at their next meeting in June.  And while they are probably not likely to lower rates in the near future, longer-term interest rates have dropped over the past two months leading to some credence we may have already experienced the peak in interest rates for this cycle.    

On the Precipice

The debate over the debt ceiling is now grabbing headlines and will likely continue to over the next few weeks. We would like to think that despite being at odds with each other, neither of the major political parties would want the U.S. federal government to default on its debt which is why we think it is very probable some sort of compromise will be reached.  The market seems to agree as it seemingly is not being impacted by the lack of compromise.  There is always a chance for a default and if we were to see one it could be catastrophic for the markets, especially in the short-term.  But our view is what is happening in Washington, D.C. is what would be considered “political theater” by both sides.  There is also a good chance of a short-term agreement to give more time to negotiate.  On a lighter note, as we have recently learned, many members of Congress trade stocks regularly so it would not be in their own personal interests to let a default occur which gives us further hope an agreement will be reached. 

Perhaps most concerning about the ongoing negotiations is the likely outcome of lifting the debt ceiling and associated increase in government spending.  Widely accepted economic thought says that increased government spending can lead to higher inflation, reducing corporate profits, and slowing job creation.  Further, empirical evidence overwhelmingly supports the view that a large amount of government debt has a negative impact on economic growth potential, and in many cases that impact gets more pronounced as debt increases. A large majority of studies on the debt-growth relationship find a threshold somewhere between 75 and 100 percent of GDP. As of the end of 2022, federal debt was 120% of GDP, already above the threshold where growth is inhibited.  Reduced economic growth and lower corporate profits are not good for the stock market, possibly making decent returns in the market harder to achieve in upcoming years.     

Looking Ahead

Debt ceiling negotiations and the associated political gamesmanship will likely continue to make headlines, but probably will not affect markets greatly.  The CBOE Volatility Index (“VIX”), popularly known as the “fear gauge” remains near historical lows, implying that volatility is limited, and markets are not expecting anything besides an agreement to raise the debt ceiling and avoid default.  But of course, as we have experienced in the past, markets can be incorrect and not fully price in risks.

On the economic front, consumer spending will be in focus this week with retail sales data set to be released as well as earnings reports from retail giants Wal-Mart and Target.  The most important data point may ultimately be the weekly jobless claims release given that last week’s reading was the highest since October 2021 and continuing jobless claims continue to inch higher.  Softening labor market trends support the Fed’s move to the sidelines and also play into concerns about the lagged effects of the tightening cycle.  This is why it seems increasingly probable the Fed will pause and take a “wait and see” approach for a few months to determine the full impact of rate hikes.  Stress in the banking sector is leading to tighter lending standards and therefore has become a de-facto tightening of monetary conditions, taking some pressure off the Fed to continue on the path of higher interest rates. 

Planning for retirement is a long, arduous task which involves substantial preparation, just like climbing a mountain.  Reaching the peak means working around the obstacles right in front of you, i.e. short term market moves, while not losing sight of the end goal.  And once you reach the summit, there can be just as much of a challenge to descend.  Let us be your guide to help ensure you successfully navigate the obstacles you may face on the downhill part of your retirement expedition and make sure your savings do not vanish into thin air. 

Have a wonderful 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