Tax Planning

Are We There Yet?

Road trips seem to be a common staple of American families during the summertime.  Despite higher gas prices, this summer seems to be no different.  I remember taking many road trips as a child.  We did not have DVD players nor most of the electronic gadgets available today to help occupy our time, plus most speed limits were only 55 miles per hour so the trips took longer.  Like most rather impatient children enduring a long ride in the car, my siblings and I would annoy our parents with the question of “Are We There Yet?”  The same question could be asked of the economy and markets today, especially as it relates to a recession. 

The answer may not be so simple and our thought is that we are not yet there.  With two consecutive quarters of negative economic growth being reported, an argument is being made that it meets the classical definition of a recession.  Besides negative GDP growth, a recession also generally entails a time when trade and industrial activity are reduced so it is difficult to justify we are in the midst of a recession with the labor market remaining strong, unemployment near historically low levels, and fairly resilient consumer spending.  As a matter of fact, some of the most watched economic releases regarding activity in the industrial sector, such as Capacity Utilization and Industrial Production, came in better than expectations last week and indicate there is not a slowdown.  Monthly retail sales also showed continued growth, although consumer spending is shifting from discretionary items to essential items such as food and clothing due to higher prices and monthly household budgets not going as far as they used to. 

Recessions are a natural part of the economic cycle and sooner or later we will experience one.  If we are not there yet, when should we expect to see one and what will be the cause?  Our estimates are that we won’t see a real recession until at least the latter half of next year or sometime in 2024.  With inflation remaining elevated above historical averages and the Federal Reserve’s comfort zone, it is expected the Fed will have to continue to raise interest rates.  Furthermore, they have not yet begun reducing their balance sheet by selling bonds, known as quantitative tightening (or simply “QT”), in earnest.  Coupled with raising interest rates, QT will lead to a lower supply of money and eventually should help lower inflation.  But it is very likely the Fed will push us into recession in doing so.  The spread, or difference in yields, between 2-year and 10-year U.S. Treasury notes remains negative, or inverted, which in the past has been a strong predictor of future recessions since it indicates anticipated weakness in future economic growth.  What may be an even more ominous sign of a future slowdown is the difference in yields between 3-month T-bills and 10-year Treasuries, which at one point did invert a few weeks ago. Shorter term bonds are much more susceptible to interest rate hikes by the Fed so when they raise rates next month, as widely anticipated, T-bill yields should be quick to follow and there will again be a negative spread between 3-month T-bills and 10-year bonds.  This time the inversion is likely to last much longer. 

When Can We Stop?

Besides wanting nothing more than to arrive at your destination, perhaps the second most asked question is “When are we going to stop?” Whether it is to go to the bathroom or get something to eat, everyone seems happy to get out of the car for a few minutes.  In the same vein, investors may want to know when market volatility will end.  It seems everyone is happy when the markets are moving in a positive direction and they are making money but when the market drops they may want to stop and take a break and may even ask themselves why they are invested in the market. There are two answers – 1) because at some point they expect the market to again perform well, which historically it has done or 2) maybe they should not be invested in the stock market.  Over long periods of time the stock market has performed very well and provided the best means to beat inflation but over shorter time periods it can be more challenging.  You should not invest money you cannot afford to lose, or that by losing your lifestyle would be negatively impacted.  As a very general rule of thumb, any money you plan on spending in the next five years should not be invested in the stock market.  Also, any money invested in the stock market should only be done once your monthly income needs are taken care of over the aforementioned time period.   

What should you do with money you need to spend in the next few years to keep it safe?  The 40 year bull run in bonds seems to be over and with rising interest rates bonds are no longer the safe haven they once were.  Do not let the recent rally in longer-term bonds fool you, it is doubtful bond yields will drop significantly from here in the near term. This means bond prices are unlikely to move higher anytime soon and any income earned will not overcome what could be lost with falling bond prices. It is different for shorter-term bonds, where we now do see yields that are enough to beat price decreases since their duration, a measure of price sensitivity to changes in interest rates, is lower.  However, shorter-term bonds are not keeping up with inflation and you are slowly losing purchasing power.  It might be time to consider other alternatives that keep your money safe yet might provide for better returns to keep pace with rising prices.  This trip has already gotten long, so we will save those ideas for another time. 

Looking Ahead

Last week was the first negative week for the stock market in four weeks so it would seem the recent stock market rally is cooling off.  We are at a crossroads; will momentum remain positive and we see further gains or with the recent run-up will the market take a break and level off?  The worst-case scenario is this was a bear market rally and we will again see the market drop to the lows experienced in June.  This coming week will bring some interesting economic releases, including Personal Consumption Expenditures (PCE) and an update to second quarter GDP.  We do not expect a significant change to the previously reported GDP number but given the recession arguments it will no doubt we debated.  PCE tends to be the Fed’s preferred measure of inflation and the year-over-year change is expected to drop slightly from last month but at over 6% remains well above the Fed’s comfort level of 2-3%.  Barring any major surprise this will most likely continue to add fuel to expectations of the Fed continuing to raise rates at their next meeting in September.  We may hear some clues about this later in the week from members of the Federal Reserve during their annual symposium in Jackson, Wyoming. 

Remember, getting to retirement is a destination but living in retirement is a journey.  Invest accordingly and make sure you are comfortable.  You will have to contend with challenges such as inflation, recessions, and market downturns throughout your journey.  Hopefully it is a long enjoyable trip, and you won’t have to stop and ask if you have arrived.  Please let us know if you would like our help in this important journey. 

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

Still in the Middle of the Desert

It may be difficult to find a movie with characters as cool and slick as those in the 2001 version of Ocean’s Eleven.  The movie is fun to watch, not just for the cast of characters but also for the sharp visual aspects and snappy dialogue.  In the early part of the movie, Danny (played by George Clooney) and Rusty (played by Brad Pitt) are recruiting members to join their gang to rob a marquee Las Vegas casino, the Bellagio. One such target is Reuben (played by Elliott Gould), who happens to be a former casino mogul and could provide the funding for their scheme.  After Danny and Rusty explain their plan, Reuben shows skepticism by telling them he has full confidence they can rob the casino but then offers a reminder that once they are outside the casino they are still in the middle of the desert, therefore making a getaway difficult.  In similar fashion, markets celebrated lower than expected inflation readings last week, but we need to not lose sight of the fact we are still experiencing the highest levels of inflation in 40 years. 

The Consumer Price Index rose by 8.5% year-over-year, which was lower than the 8.7% expected and 9.1% reported the previous months.  Similarly, the Producer Price Index increased by 9.8% compared to a year ago, less than expectations of 10.4% and last month’s reading of 11.3%.  Month to month, the CPI was flat and did not show a gain while the PPI showed a decrease in prices of 0.5%.  These numbers were greeted with enthusiasm from the markets, leading the S&P 500 to a gain of over 3% for the week. Year over year inflation remains high but appears to be slowing, especially given there was not an increase from a month ago.  But does this mean we have reached peak inflation?

The month-to-month numbers can be volatile, so it remains to be seen if this is the beginning of a trend lower or a single month anomaly.  Back in April, inflation was reported as being lower than March, just to reverse course and increase in subsequent months.  Energy prices are leading the way lower and are very much attributable to the lower inflation readings. We are nearing the end of the summer driving season and have already seen a reduction in energy demand but short supplies remain and we would expect energy prices, especially natural gas, to rise over the cold winter months.  There have been encouraging reports regarding the situation in Ukraine, but even if we were to see a pullout of the Russian troops the damage that has been done, not only to Ukraine’s infrastructure but also with Russia’s standing in the world and trade partners. This could take many years, if not decades to mend.  In the meantime, food and energy prices are expected to remain high. 

You Need a Dozen Guys

Every person has their own rate of inflation based upon how they spend their money and there are many different components, so while energy is a major factor we also need to consider all that contribute to overall inflation.  On a macro-scale, supply chain issues seem to be improving and energy prices are moderating, if not slowly easing, but inflationary pressures remain, especially with food and housing.  Housing costs, which in CPI is measured by the cost to rent and not home prices, remain elevated and tend to be sticky so it is doubtful they will fall.  However, they seem to be stabilizing as the real estate market cools off.  Our expectation is that inflation, more specifically year-over-year price increases, will moderate and we will continue to see lower readings than what we’ve seen over the past several months.  But we also expect inflation to remain at levels higher than what we’ve experienced over the past two decades.  Even if inflation were to drop to the 5-6% range over the next year, it would continue to have a profound effect on retirement savings and future purchasing power. 

Despite lower readings last week and because inflation remains elevated, the Fed is expected to continue raising interest rates.  Their next meeting is in September and current expectations are for either a half point or three-quarter point increase with additional increases at their November and December meetings.  The Fed remains somewhat behind the curve since inflation remains stubbornly high but with softening inflation numbers, the odds of a soft landing seem to be increasing.  This is reflected in the stock market as the S&P 500 has rallied nearly 18% since it’s low in mid-June.  If we look back at history, after inflation peaked in 1974 and 1980, stock markets rallied and presented very robust returns over following years. 

Looking Ahead

Even if pricing pressures are diminishing and inflation is rolling over, it remains elevated and continues to eat away at the purchasing power of consumers.  Fortunately, there has been a recent reprieve for investors and savers in the form of better market returns and higher interest rates.  We expect inflation to remain above average for at least the next couple of years so while we welcome a better outlook with open arms, it is premature to declare victory.  The last few weeks of August tend to be relatively quiet in terms of the markets.  There are still some companies to report earnings and economic releases will be closely watching, including updates to GDP and Personal Consumption Expenditures (PCE) in a couple of weeks. 

Most people think that a market downturn is the greatest risk when preparing for retirement, but there are many other things to consider such as taxes and inflation.  For the first time in several decades, the latter continues to take center stage.  And while recent reports are encouraging, we need to remember that inflation has not yet been tamed.  When preparing for retirement, it is vital to have a sound financial plan which includes multiple sources of income and assets to overcome inflation so you can maintain your lifestyle. This is a long game, so don’t declare victory early just to find yourself stuck in the desert later in life. 

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 One Thing

In the hit 1991 movie City Slickers the city-dwelling main character, Mitch, played by Billy Crystal, is on a cattle drive with two friends trying to find deeper meanings in their lives while out on the range.  A gritty cowboy, Curly, played by Jack Palance, tells Mitch the secret to life is simply “one thing.”  It is up to Mitch to figure out the one thing most important in his life since it is different for everyone.  Focusing on one thing may be good advice for most individuals, however for larger institutions, such as the Federal Reserve, it is decidedly more complicated.

The primary goal of a central bank is to provide price stability for their country’s currency by controlling inflation.  Integral components of this are to manage the money supply and foster steady economic growth.  The central bank of the United States, the Federal Reserve, has a dual mandate: price stability and maximize employment.  But in the current environment these seem to be at odds with each other.  Low unemployment is causing wages to increase at a quick pace, creating upward pressure to the prices of goods and services.  The Fed has been on a path of increasing short-term interest rates throughout 2022 in an effort to bring inflation down to a level more conducive to promoting economic growth.  If they continue to raise rates, conventional thought is it will cause a slowdown in economic growth and perhaps lead us into recession, likely having an adverse impact on employment.  The Fed has explicitly stated they are willing to do this if it means they can get a handle on inflation.  But based upon the latest employment report, the Fed’s efforts are not working when it comes to the labor market. 

The larger than expected payroll and unemployment reports last Friday show that the labor market remains very resilient and the Fed’s interest rate hikes have had limited, if any, impact on employment.  Wages also increased year-over-year by a larger than expected amount, showing wage pressures are not yet moderating.  This gives the Fed ammunition to continue their current path of rate hikes with at least a half point rate hike likely in September, with increasing odds of another three-quarter point hike.  This is why the stock market reacted negatively to the employment reports and bond yields spiked.  A week ago we were talking about the probability of the Fed reversing course in 2023 and beginning to lower interest rates. That scenario remains a possibility but if economic reports show inflation continuing at elevated levels over coming months it will force the Fed to continue raising interest rates. 

Keep them dogies movin’

It seems a foregone conclusion the Fed will raise interest rates at their next meeting in September, but there are still economic reports, namely inflation and employment, in the interim so there will very likely be changes in expectations for the magnitude of the interest rate hike.  However, monetary policy can also work without central bankers doing anything. After the jobs reports, short-term and long-term bond yields surged with expectations of future interest rate increases.  These higher rates will filter through to rates on mortgages, auto loans, and other forms of credit, having an immediate effect on demand. 

We continue to closely monitor the bond markets, where we have seen a great deal of volatility recently.  The spread, or difference in yields, between the 2-year and 10-year U.S. Treasury remains “inverted” with the 2-year yielding about 40 basis points, or 0.40%, more than the 10-year bond.  Historically this has been a forewarning of a recession, especially when the inversion is this deep and prolonged. But it is difficult to see a recession occurring anytime soon with such strong job growth and a low unemployment rate. 

Earnings reports continued in earnest last week with somewhat mixed results but overall could be considered resilient in the face of recent economic data.  Companies continue to report revenue and earnings above previously lowered expectations.  The market sold off last Tuesday, just to reverse course on Wednesday with the S&P 500 ending the week nearly flat, while the Dow Jones Industrial Average had a small loss and the Nasdaq enjoyed about a 2% gain.  We continue to see strength in technology, which had been the most beaten-up sector this year.  Oil prices continued to pullback on fears of slowing demand. Prices at the pump have been declining since mid-June with demand falling to levels not seen since the early days of the pandemic.  This is what is known as demand destruction, which occurs when high prices cause consumers to change behavior and purchase less of a good, leading to lower demand and lower prices.  It is unlikely that demand will continue to fall markedly past current levels, especially on a sustained basis, we doubt oil and gas prices will drop significantly from here unless ongoing supply constraints are eased.  Lower energy prices could be reflected in upcoming inflation reports, possibly giving some reprieve to the Fed, but not appreciably enough to give them pause. 

Looking Ahead

Over the past couple of decades when we experienced relatively benign inflation, arguably the most watched monthly economic report each month was the Nonfarm Payrolls report since job growth is generally accepted as a strong indicator of the health of the overall economy.  Now with inflation running at 40-year highs, the inflation reports are also taking center stage.  Consumer Price Index (CPI) and Producer Price Index (PPI) numbers will be released this week with the CPI and PPI expected to show year-over-year price increases of 8.7% and 10.4%, respectively.  If they came in at these levels it would be lower than the previous month and could lend credence to the notion we have reached “peak inflation” with price increases slowing.  This would be welcomed news from the Fed, but inflation remains at very elevated levels and the Fed would have further work to do.   

While the spotlight remains on the Fed and inflation, stock markets are driven over the long term by corporate earnings. Profits are affected by higher prices since input costs tend to be higher and demand is generally weakened.  A reduction in the pace of inflation would likely lead to some tailwinds for the stock market.  From an investing perspective, quality of earnings is once again in vogue and we will continue to watch earnings reports over the next couple of weeks.  When it comes to retirement, your focus should be on one thing – feeling secure.  If you would like to discuss your retirement financial plans in detail, please do not hesitate to contact us. 

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

To Be or Not to Be

Shakespeare’s Hamlet character uttered these words wondering if he should continue to be, meaning to exist or remain alive, or not to exist.  Hamlet’s debate was internal with himself, but a similar debate is now taking place on a much larger scale regarding a recession – are we in the midst of one or are we not?  The preliminary GDP report for the second quarter showed negative growth, following negative growth during the first quarter of the year.  Conventional wisdom is that two quarters of negative GDP growth is a recession.  However, it can be argued while the economy appears to be retracting, at least on a real, or inflation adjusted basis, employment and industrial production remain strong while consumer spending has not collapsed.  Are we in a recession or are we not? And if we are, how much does it matter to investors, especially those in the stock market?

The headline GDP number is reported on a real, inflation adjusted basis, but digging deeper into the GDP report shows the overall value of all goods and services produced increased by 7.8% compared to a year ago. Factoring inflation of nearly 9% results in a contraction of 0.9%, the headline number reported.  Looking at these numbers, if we indeed are in a recession, it is shallow and fairly mild thus far.  However, if it were to continue for a prolonged period then it could impact employment which in turn would lead to issues with consumer spending and housing, causing the recession to deepen further. While there is argument over whether or not we currently are in a recession, most economists seem to be in agreement the U.S. economy is losing momentum and the probability we will experience a recession is increasing.   

There was a plethora of events during the past week, including earnings reports from major tech companies which currently make up a very large portion of the S&P 500 and therefore directly impact how the overall market performs.  Alphabet (f.k.a. Google) and Microsoft earnings were worse than analyst estimates, but both stocks rallied since the reports were not as bad as feared but more importantly both gave positive outlooks.  Apple and Amazon both had positive earnings reports beating lowered expectations and also provided positive outlooks.  Earnings reports from these giants produced strong momentum for the stock market with the S&P 500 gaining nearly 4% on the week.  The recent focus on the Fed and inflation is because higher interest rates lead to higher borrowing rates and inflation tends to damper spending, both of which would negatively affect corporate earnings. The market has been adjusting accordingly via the pullback experienced this year but if future expectations improve the market could reverse course. This is precisely what we’ve seen over the past six weeks as the S&P 500 has bounced roughly 11% from its lows in mid-June. 

Much Ado About Nothing

Most of the time a three-quarter point rate hike by the Federal Reserve would be very big news but given the other events of the week it may be easy to overlook.  Future expectations for interest rate increases have shifted dramatically in the past month as economic data is showing a slowdown in activity.  In his remarks after the Fed meeting, Chair Jerome Powell stated there are signs of a slowing economy and future rate hikes will be data dependent.  This was cheered by the markets as it is an indication that future interest rate increases are likely to be lower than previously expected; the most aggressive of the Fed’s actions to raise interest rates may now be behind us. Fear of the Fed raising rates too high and keeping monetary policy restrictive for too long was a concern causing headwinds for equity markets.  While very much still a possibility, some of this fear seems to be alleviated with Powell’s comments.  The markets, especially the bond markets which tend to be a good predictor of future activity, are indicating the Fed will continue to raise rates through the end of this year but will have to pivot and lower rates in 2023.  It will remain to be seen if market expectations are correct or if the Fed will need to remain on a path of raising interest rates.  

Future Fed action is ultimately dependent upon inflationary pressures, some of which may be beginning to abate.  Oil prices have pulled back slightly and moderated (but still remain stubbornly high.) Many commodities experienced price decreases of 20-30% during the month of June. Comments during recent corporate earnings calls also indicate pricing pressures seem to be abating.  The government’s inflation reports reflect changes in price levels over a certain period of time, either month-to-month or year-to-year.  Compared to a year ago, prices are markedly higher but given what seems to be a stabilization in prices recently, future inflation readings, especially once we get into 2023, could show lower changes in price levels.  This could be a catalyst for the Fed to reverse course, especially if at that time we are in a recession. Ironically, the stock market is viewing the prospects of a recession positively since recessions tend to be deflationary as demand decreases, often causing prices to drop or at least stop increasing.  Inflation and higher interest rates have created the biggest weight on the markets this year, so if the prospects for continued inflation are waning it could prove to be a boon for investors. 

Looking Ahead

After all of the excitement in the markets this past week, a quieter week may come as a welcome reprieve.  Earnings reports continue in earnest and it is earnings that drive the markets over the long-term, which is why so much attention is being given at this critical juncture. The major economic release of the week is the employment report on Friday, expected to show the labor market remains robust with low unemployment.  A high level of employment produces higher wages and inflation, further complicating the work of the Fed.  In order to engineer a soft landing, the Fed needs to reduce wage pressure while not causing substantial harm to the employment situation.

The recent mini-rally is leading to improvement in investor and consumer sentiment, both of which had reached historically low levels.  If sentiment continues to improve, which we expect it will on the heels of last week’s activity, it should help provide further thrust for the markets. Should investors care if we are in a recession or not?  Markets tend to be a leading economic indicator; they will tell you what the economy will do.  The economy will not tell you what the markets are going to do.   If you would like to discuss your portfolio to ensure it is positioned for whatever occurs in the markets and economy, please do not hesitate to contact us. 

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

Bottoms Up

The term “bottoms up” is most often associated with a toast or telling people to finish their drinks, implying the bottom of the drink glass is being raised as the drink is consumed.  In business, “bottom up” refers to taking action based upon feedback from lower levels of a hierarchy, generally front-line employees.  And in investing, “bottom-up” refers to making investment decisions based upon individual security selection or sector analysis, as compared to top-down analysis which takes a larger view and begins with analysis of the macroeconomic environment.  (Author’s note: In our updates we tend to discuss much more of the macroeconomic environment and market conditions, compared to looking at individual stocks and sectors, so this would be considered top-down analysis.)  But now might be a good time to contemplate whether this is a “bottom up” situation, one different than any described above – has the stock market bottomed and are we on our way back up?   

We will not definitively know the answer to that question for several months, but there are several indications the markets may have bottomed about a month ago.  Thus far the markets have had a strong showing in July with the S&P 500 being higher by about 5%, led by the stocks most beat up this year – technology.  Interest rates saw a spike in mid-June and have since retreated, providing a reprieve to growth stocks whose values are vulnerable to interest rates since stock prices reflect estimates of the present value of future earnings.  We have also experienced a pullback in commodity prices, including energy, giving hope that inflation may be moderating.  Despite this bounce, the S&P 500 remains about 15% off its all-time highs reached earlier this year.

Fears of an impending recession have been exacerbated by the inversion of the bond yield curve with 2-year U.S. Treasuries now yielding more than 10-year U.S. Treasuries.  Ironically, even though the bond market is signaling a slowdown the stock market is viewing this as a positive since a recession could help quell inflation and eventually lead to lower interest rates.  A slowdown in economic activity during a recession is likely to lead to lower demand, alleviating upward pressure on prices. Recessions can even be deflationary, depending upon the severity and length. 

Grab Your Drinks

Much attention is paid to monthly economic releases, but over time corporate earnings drive stock market returns more than any other factor.  Earnings season is gearing up in earnest with some of the largest tech companies reporting this week. The earnings already reported show that demand remains solid but inflation is providing headwinds.  Tight labor markets continue to cause issues, contributing to higher costs and hindering growth prospects.  Many companies expect inflation to moderate during the second half of the year.  Earnings expectations have already been lowered and the earnings reported so far have not been spectacular with only a handful of names beating expectations.  The fact that earnings have not been worse than the lowered expectations does provide optimism and is providing a boost to the stock market.  And there is still much more to come, so grab a drink and watch what happens with earnings reports over the next few weeks; they will drive the markets and provide a clearer picture on whether we are indeed moving off the bottom and on the path to recovery. 

We also cannot forget other highly anticipated events of the week, especially the Federal Reserve meeting.  It is widely expected they will raise interest rates by three-quarters of one percent or 75 basis points (a basis point is equal to 0.01%).  After the hotter than expected CPI report a couple of weeks ago there was speculation they would raise rates by a full point but that has now been mostly suppressed after recent comments from Fed officials.  At this time, it seems likely the Fed will raise rates by at least a half point, or 50 basis points, at their September meetings.  Inflation may be abating and with the potential for a recession on the horizon there is some thought the Fed will have to reverse course and begin to lower rates sometime in 2023.

Looking Ahead

It is going to be a very busy week with earnings and the Fed, as well as the Personal Consumption Expenditures (PCE) and Gross Domestic Product (GDP) reports.  The PCE Deflator is the Fed’s preferred gauge of inflation and, similar to CPI, is expected to remain elevated and well above the Fed’s comfort level of 2-3% annual inflation.  With all the events of the week, it is the GDP report which will likely garner the most attention.  The technical definition of a recession is two consecutive quarters of negative GDP growth, a.k.a. economic contraction.  GDP was negative in the first quarter of this year so if this report is also negative, we could “technically” already be in a recession.  Where it gets interesting is that the headline GDP is reported on a real basis, meaning that growth is measured and then adjusted for inflation.  So even though there could be positive economic growth, factoring in inflation will make it appear to be negative.  On a nominal basis, GDP growth is very likely to remain positive so if the report comes in showing contraction, it may be disputed as to whether or not we really are in a recession. 

We remain hopeful the recent stock market strength is the beginning of the bounce from the bottom and this is not merely a short-term bear market rally.  This year has been a real wake-up call for some people, especially for those who became complacent over several years of bull markets.  We remain very optimistic for long-term market prospects but continue to acknowledge there will be volatility over shorter time periods.  Be sure your portfolio is aligned with your level of risk. Both your risk tolerance, what you can handle emotionally, as well as your risk capacity, what amount of money you are able to lose and maintain your lifestyle.  Please give us a call if you would like to discuss your situation. If you are interested in hearing more of our thoughts on the markets, including our outlook for the second half of the year be sure to join us for our monthly Lunch & Learn on July 25^th, either in-person or via livestream online.   

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

Runaway Train

A runaway train is one which operates at unsafe speeds due to loss of operator control.  The thought of such an event is likely to conjure images of panic for passengers and anyone in its path.  Higher than expected inflation reports last week added to fears inflation is becoming runaway.  Has the Federal Reserve lost control? Is inflation on a trajectory to become runaway?  We won’t have definitive answers to these questions for a few months, but we can offer our thoughts and assessment. 

The Consumer Price Index (CPI) increased by 9.1% over the past twelve months; the most since 1981.  This reading was even hotter than the previous few months and above expectations, indicating that inflation is continuing to accelerate.  The Producer Price Index (PPI) was higher by a whopping 11.3% compared to a year ago; much higher than the 10.7% consensus estimate.  All inflation numbers seem to be suggesting that inflation is continuing to accelerate.  Both CPI and PPI are reported with “headline” numbers as well as “core” where food and energy, which tend to experience greater price volatility, are removed.  But it is food and energy, along with housing, that are causing the most pain for many Americans and leading to such soaring levels of inflation.  In fact, the Federal Reserve last week even acknowledged the Core CPI and PPI should now be largely ignored since they are not reflective of what most Americans, and people all over the globe, are experiencing.  Gas and food prices are now taking up the largest percentages of household budgets in a generation, if not longer. 

It is no surprise the Fed is seemingly well behind the curve when the Federal Funds target rate is 1.75% and inflation is over 9%.  Action taken thus far seems to be having a very muted impact on inflation.  However, we do need to acknowledge if often takes many months for tighter monetary policy to have a discernible impact on the economy. It tends to take about 6 months to experience the full effects of an interest rate increase and the Fed only began to raise rates in March.  But we now know the threats of inflation were largely ignored for too long and the Fed had a late start and are now trying to catch-up.

Stopping the Train

Stopping a runaway train can be very difficult, especially to do so in a manner where nobody is hurt. The same is true of inflation.  At this point it seems the outcomes will be either inflation truly becomes runaway and causes structural damage to the economy from a long-term reduction in confidence or is contained by the Fed via higher interest rates, which also has the potential to cause damage since it would likely lead to a recession.  There is a chance inflation will “fizzle” out on its own via increased supply, which would imply the supply chain issues we’ve experienced over the past couple of years are resolved, and/or reduced demand from lower spending.  The Fed has very little, if any, control over supply but higher prices and higher costs of borrowing could reduce demand. 

On the demand side, an increase in money supply is perhaps the largest driver of inflation.  The Fed has begun a quantitative tightening (QT) program by selling bonds they held on their balance sheet, sucking money out of the economy. But they have much work to do to get enough money out of the system to have make a noticeable difference in reducing demand to help lower inflation. 

Commodities prices have fallen rather dramatically over the past month, which was not reflected in the most recent reports.  Housing costs, which are the largest component of CPI showed continued increases in the latest report, but there are now reports of listing prices of homes for sale are being dropped which is likely to lead to a moderation, if not some pullback, in housing prices and reduction in housing costs.  A lot can happen over the next month but early indications are we could see a bit of a softening in the inflation reports next month.  We want to stress this is merely a prediction on what the reports will reflect based recent price changes.  It does not imply we think inflation is moderating; in fact we think it will remain elevated through at least the end of the year. 

Looking Ahead

Odds of a 100 basis point, or 1%, interest rate hike by the Fed at their meeting next week have increased greatly.  Previously it seemed to be a foregone conclusion they would raise by 75 basis points, or three-quarters of 1%, with the possibility of only a half-point hike.  That changed after last week’s inflation reports and it looks like it will be either a 0.75% or 1.00% hike as the Fed tries to be more aggressive in their fight with inflation before it becomes out of control.  But if the Fed does hike more aggressively, it also increases the chances of pushing us into a recession. 

Earnings season kicked off last week with many of the major banks reporting.  Earnings drive stock prices and historically we see the stock market move higher 75% of the time during an earnings season.  However, expectations are now being lowered with less consumer activity, higher expenses, and headwinds from higher interest rates.  The earnings already reported were largely disappointing, with local favorite UnitedHealth Group beating estimates and being a notable exception.  Thus far we are not being given much reason for optimism.  However, it is still very early in this earnings cycle and positive surprises could help bolster the stock market, leading to some upside momentum.  Between earnings, the Fed, and the quarterly GDP report, there will be much to pay attention to for the remainder of July. 

Be sure your portfolio is protected and you do not find yourself in an uncontrollable situation that threatens your lifestyle.  A falling stock market and higher costs are leading to some trying times.  We are here to help you feel secure in your retirement, so please give us a call if you would like help ensuring you have complete control over your long-term financial plan. 

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.   

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