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So far Todd Kirsch has created 25 blog entries.

Your 2022/2023 Year-End Guide

To ease some of the burdens of the upcoming tax season, this helpful guide will help you become familiar with important dates, deadlines, challenges, and opportunities that may come up toward the end of the year.

Of course, if you have additional questions about anything included in this guide, please call (303)647-1220.

We look forward to working with you this tax season!

Download Your Guide Here

By |2022-11-08T20:27:26+00:00November 8th, 2022|Uncategorized|0 Comments

The Jury is Still Out on Mr. Market

As we’ve been discussing in this blog since the Spring, the Federal Reserve’s hiking of interest rates will result in one of three outcomes: a recession (perhaps a deep one), stagflation (combination of high inflation and low or even negative growth), or a “soft landing” (the economy avoids a recession while inflation comes down meaningfully). Here we are many months later, and the jury is still out deliberating – we simply don’t know yet how this will play out. In the meantime, interest rates have soared to levels we haven’t seen in decades pummeling bond prices along with stocks. For investors who thought they had conservative portfolios, this has been an especially painful drawdown.

Is There Any Hope Out There?

Yes, there are certainly some reasons for optimism, but it’s quite possible that markets will deteriorate further before they get better. A recession in 2023 is not a foregone conclusion, but it’s certainly looking more likely. But consider that stocks might already be priced for a recession…this certainly looks true for small and mid-sized companies.[1] The money supply (M2) has continued to grow at a very slow pace for the last 6 months, which helps inflation – though it takes about 12 months to impact the inflation numbers. And there are many signs that inflation is cooling in key areas that were red hot: you don’t have to look any further than housing – with mortgage rates near 7%, home prices have run into a wall.

The Bear Has Also Gotten to Bonds

The terms “bear market” (price drop of 20% or more) and bonds don’t generally belong in the same sentence. But they do this year. By far, this is the worst year on record for bonds. Even conservative, investment-grade bond funds are down 20% and more this year.

But here is the good news with bonds: assuming the issuers of the bonds don’t default, then the bonds will mature at par value (i.e., the original cost of the bond). As the bonds approach maturity, they will regain their losses (up to par value).

Let’s use an example. Let’s assume you purchased a $1,000 U.S. Treasury bond yielding 2% last year, and its value has dropped to $950. Today, you’re not feeling very good about a 5% loss in value on “safe” investment. However, if you hold onto the bond until it matures in another year, then you will receive $1,000 from the U.S. government. You would therefore receive a $50 gain to maturity plus another $20 in interest. From here, that would be a return of 7.37%.

And if interest rates decrease between now and maturity – they typically do during recessions – then bonds could see substantial gains in value prior to maturity. Right now, markets are pricing inflation at 2.69% over the next five years.[2] If that comes to pass, then interest rates should drop alongside inflation in the next few years and boost the value of bonds.

Stick to Your Financial Plan

Investors are prone to making big mistakes at market bottoms and market tops. We’re all human, so it’s understandable that emotions would begin creeping into our thinking when markets move too far in one direction. The emotion is always rooted in fear: fear of loss and fear of missing out. If you’re feeling some fear right now, it’s understandable. But it’s crucially important that you do not act on the fear and exit your security positions.

And now, the boring but important stuff: There are three general asset categories: cash, bonds, and stocks. The key to financial planning is matching these categories of assets to the time in which you will need the money from your investments to fund the goals set in your financial plan. For goals coming due within 2 years, you should have enough cash on hand to cover those expenses (or anticipated cash from investments and other sources). For goals coming due within 3-7 years, we recommend bonds or other income-oriented investments. And for goals coming due 8 or more years from now, we recommend that you invest in stocks. Please remember that, on average, we recover from equity bear markets in a little over three years, so I hope this provides some comfort that you can wait out these downturns with some confidence.[3]

If you’ve done the proper financial planning, then this should help keep emotions out of investment decisions. Why would anyone liquidate a beautifully constructed portfolio of stocks when they won’t be needed for at least 8 years? Yes, bonds will be needed sooner, but we’ve already covered the built-in price appreciation you will get with bonds.

Don’t Forget the Opportunities Mr. Market is Presenting!

Roth Conversions

It’s a great time to consider a Roth conversion. For married people, tax rates are scheduled to remain lower through 2025, so considering a Roth conversion was a good idea anyway. But now it’s even better when you can move securities – at depressed prices – into a Roth IRA where, over time, they should rebound in price inside a tax-free vehicle. There are a lot of considerations prior to converting to a Roth IRA, so please obtain professional tax and financial planning advice prior to proceeding.

“Tax Loss Harvesting”

In taxable accounts, it’s an ideal time to sell securities to “harvest” losses to offset present and future gains. The idea is to sell an existing security that has a loss and reinvest in a similar security so that you remain invested. You cannot reinvest into the same security for 30 days or the IRS will disallow the loss.

Annuities

With higher interest rates, annuities are attractive again. They’re not appropriate for every situation, but they can be an excellent solution for certain situations. There is a lot to consider before purchasing an annuity. You give up liquidity, but you eliminate some important risks in your financial plan.

Certificates of Deposit (CDs)

We’re now seeing rates above 4% for brokered CDs that mature in one year. Considering that banks remain stingy on what they are paying bank depositors, a brokered CD might be a good option for your excess cash.

Conclusion

This has been one of the most difficult market environments I have ever seen.  But there is no reason to panic.  Stay patient, stay disciplined, and stay invested.

[1] https://www.yardeni.com/pub/stockmktperatio.pdf
[2] https://fred.stlouisfed.org/series/T5YIE
[3] https://www.wsj.com/articles/SB10001424052702304732804579421721615322340
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Marshall Investment Management, LLC, a registered investment advisor. Marshall Investment Management, LLC and Kirsch Wealth Advisors are separate entities from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

By |2022-11-01T17:06:52+00:00November 1st, 2022|Uncategorized|0 Comments

Stocks Had Their Worst Start Since 1970…But My Inner Optimist is Waking Up

“What’s glaringly missing in the headlines is that in 1970 the S&P 500 lost 21% in the first six months but recovered 27% in the second half. And that’s not the only example of significant second half turnarounds.”
– LPL Research Note to advisors on 6/30/2022.

Perhaps you’ve heard it 11 or 100 times in the last week or two: the first six months of 2022 was the worst since 1970. True, it was. In fact, we saw the S&P 500 decline 23.6% from its previous high. The NASDAQ was worse.[1] Mainstream bond indexes piled on by declining over 10%. The year 2022 has undoubtedly been a tough year so far.

More noteworthy even than the extent of the decline was its gathering violence in mid-June when the market ran off a streak of five out of seven trading days during which 90% of the S&P 500 stocks closed lower. This is one-sided negativity on a historic scale. According to LPL, the S&P 500 declined more than 5% each in back-to-back weeks in mid-June: something that’s only happened seven other times since WWII.

Don’t Do It!

And now you can probably guess what I am going to say: historically, the best way to destroy any chance for lifetime investment success has been to sell one’s stock holdings into a bear market. Selling when everyone else is selling must strike us as the height of foolishness. It might feel good in the moment to sell, but these are generally mistakes from which investors never recover. Think of it another way as succinctly stated by one of my long-term mentors: stocks are returned to their rightful owners during bear markets.

As previously stated in these emails – and why stock prices are suffering so much – market participants are primarily concerned that the Federal Reserve will raise interest rates too high and drive the economy into recession.[2] If they do, then so be it. There is nothing to be done about it. And we certainly would prefer a temporary recession and another 10% to 15% drop in stock prices rather than the scourge of sustained and elevated inflation. Rather than focusing on recession or where things might be headed in the short-term, it is my mission to help you stay focused on the goals set in your financial plans while allowing dividends on your stocks to be reinvested at lower prices. And if you’re still working, even better…each contribution to a retirement account is buying shares at a lower price. Remember – and we are VERY disciplined in this with financial plans – you do not need to liquidate ANY stocks in your portfolio for at least seven years. So why on earth would it matter if we go into a temporary recession?

Why Inflation Is Probably Peaking

Let’s move on to the good news. The enormous growth rate of money in the economy (“M2”) that caused the inflation is now crashing down. The May number was released on June 28th.[3] And it was beautifully low. We have now strung together four impressive months of low money growth that has now averaged only 1.8% annually. For context, M2 averaged around 6% annual growth each year prior to Covid, and we were solidly over 10% growth in the first quarter of this year. It’s been an impressive turnaround the last 3-4 months.

The current money in the system is still out there, so inflation will persist for a time. And there are certainly energy, food, materials, war, labor, and supply-chain issues that will linger. But the main driver of inflation is now turning the other direction. My Inner Optimist likes what he’s seeing for the first time in months.

According to Scott Grannis (where I got the chart above), this is the “most important chart in the universe right now.” M2 exploded right along with government spending, and, well, you don’t need a PhD in economics to figure that one out. The only thing surprising is that the PhDs at the Fed were surprised by the inflation we got. The Fed and the government did a cash dump into the system at a time when supply was crimped by Covid and simply couldn’t keep up with demand.

It’s not entirely clear what the Federal Reserve will do with interest rates going forward. Three months ago, I would have said that a “soft landing” by the Fed was near a zero probability (meaning that inflation is brought meaningfully back under control without triggering a recession). I’m reluctant to put a probability on it now, but I think it’s more than a mere possibility – it might even be approaching probability. Economic growth is clearly slowing in the economy. At some point, this should slow inflation, especially when combined with slower money growth. As mentioned in my last post, there is a lot to like in the economy from strong company earnings estimates to strong consumer and business balance sheets to a low unemployment rate.

We’ll know more in the next month or two as companies report second quarter earnings and, perhaps more importantly, provide guidance on how inflation is impacting their businesses. If companies have a tough time handling inflation and guide earnings estimates lower, then we are probably in for some further pain. But if we get solid earnings reports along with any positive inflation data, then perhaps the Fed backs off a bit on interest rate increases…that could be very good for markets.

My Inner Optimist is waking up. Stay patient, stay disciplined, and stay invested.

[1] The beginning of the downturn in growth stocks started in February of 2021, accelerated in November of 2021, and hasn’t stopped. Growth stocks are more sensitive to inflation and rates because the cash flows from these companies are further out into the future. If you took a finance class in college, remember one of the main finance principles: would you rather I pay you a dollar today or a dollar tomorrow. The answer is always today, because it’s worth more. And this is especially true in an inflationary environment when that dollar would be worth even less in the future.
[2] As an aside, bondholders are more concerned about inflation than recession. Inflation erodes the real value of future interest payments. In a recession, a bondholder is concerned about default, but they are higher in the corporate capital structure and would get paid prior to stockholders.
[3] “FRED St. Louis Federal, June 06, 2022.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Marshall Investment Management, LLC, a registered investment advisor. Marshall Investment Management, LLC and Kirsch Wealth Advisors are separate entities from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
The information contained in this email message is being transmitted to and is intended for the use of only the individual(s) to whom it is addressed. If the reader of this message is not the intended recipient, you are hereby advised that any dissemination, distribution or copying of this message is strictly prohibited. If you have received this message in error, please immediately delete.

By |2022-07-11T19:15:49+00:00July 11th, 2022|Uncategorized|0 Comments

Another Bad Inflation Number…and Why You Shouldn’t Care

Last week, the government released the May inflation report. The news wasn’t good – and markets sold off. On top of that, we are apparently in one collective bad mood, at least according to the well-respected Michigan Consumer Sentiment survey. The lowest sentiment number ever recorded was just released in the most recent survey.[1] It’s hard to blame consumers when there is a gas “scoreboard” broadcasting the pain on street corners everywhere and, like the Progressive Insurance commercials, you find yourself turning into your parents by discussing grocery store price increases. But there is some good news under the surface that you might not be hearing about. And with a properly designed financial plan, you’re ready for whatever markets throw at us.

Recession, Stagflation, or Soft Landing?

Assuming no more shocks to the system, it’s widely assumed that things will likely go one of three ways: one, the Federal Reserve (the “Fed”) engineers a “soft landing” as we return to 2% inflation while maintaining positive economic growth; two, the Fed is unable or unwilling to control inflation, and we end up in a sort of elevated inflationary period with weak or even negative economic growth (i.e., “stagflation”); three, the Fed follows through on their recent tough talk and sends the economy into recession by significantly raising interest rates to get inflation under control (a recession is generally defined as consecutive quarters of negative economic growth).

Now, as a long-term, patient, and disciplined investor – with goals set within your financial plan that have investments matched to that time when you will need that money – can I please remind everyone: who cares which way this goes! There is nothing to be done about it. And only a novice would try to time markets by withdrawing capital from investments at just the right time (and that time has passed) and then hope to be correct a second time by deploying capital back into investments later on when stock prices bottom out. Stock prices will turn up well before the data show that everything is getting better. The only way that we can be sure of capturing the superior returns of stocks is by staying invested, period. A great way to impair your progress – permanently – is to try to time markets.

Recessions come, recessions go. It’s a natural process in a capitalist system that washes away the excesses of prior decisions that, in retrospect, seem rather dumb. Assuming you don’t need your capital from stocks when the recession arrives – and you certainly shouldn’t with a proper financial plan – then let markets do what they will do. An average recessionary bear market typically cuts about 35% off the S&P 500 index. As of this writing, we are well over halfway there, assuming that’s indeed where we’re headed. If the Federal Reserve breaks inflation with a recession, then stop and think about the other side of that. In the five years from August 1982 to August 1987 (after the Fed broke “The Great Inflation”), the S&P 500 tripled![2] So maybe the real risk is missing out on a 300% gain rather than on another 15 to 20% decline.

Inflation

Now that we’ve established that no action should be taken that will permanently impair your progress, let’s soberly assess our inflation problem and why it might stubbornly persist for a while.

There are two main problems with inflation. First, there is too much money in the system from the enormous amount of fiscal “stimulus” that the government injected into the economy. Second, we have a supply problem, most obviously with energy, labor, food, and other niche things like semiconductor chips.

The Amount of Money in the System

There is about $4.8 trillion of excess money sloshing around out there. For perspective, there is a total of about $22 trillion of money, or what is called “M2”. This money has caused a classic “Economics 101” scenario to unfold: too much money chasing too few goods and services. This will take time to fix. Critics say the Fed is responsible for buying too many government bonds to finance government spending and keeping interest rates too low for too long – both of which led to more money creation. They’re probably correct.

The Federal Reserve can lower the money supply by discouraging borrowing. They do this by raising interest rates. Less borrowing means less money creation. For how money is created, see my March 18th post. But for now, the Fed is nowhere near “tight” with monetary policy – we’re still sitting on a one percent short-term interest rate versus 8.6% inflation.[3] That’s the furthest thing from tight…meaning a recession is probably not on our doorstep. But the Fed’s tough talk combined with higher commodity prices appear to be tightening monetary conditions without drastic action by the Fed.

So now the good news: these tighter conditions already seem to be impacting the supply of new money, as the growth rate in the money supply substantially slowed over the last three months.[4] Frankly, I’m surprised at the turnaround in this number. Perhaps we can now claim that there is a light at the end of the inflation tunnel. If the money supply continues to cooperate, then that should help bring down inflation later this year or next (there is typically a lag on inflation following money supply changes).

Supply Problem

Here is where the Federal Reserve is stuck. They cannot create more oil, more diesel fuel, more semiconductor chips, or chicken, beef, eggs, etc. In fact, by raising interest rates, they run the risk of reducing supply even more. Management teams might think twice about borrowing more money to expand supply when the cost of that capital is now higher. Sure, in the right situations, that will happen. The Fed needs to be very careful here. The war in Ukraine and the fallout have pressured supplies even further. Let’s talk energy.

Energy Supply

Things don’t get better here. Most reasonable people are all-in for a carbonless world, but the facts of our energy consumption say that is unrealistic for now. Doing research for this post, I set out to see what the latest trends are from renewable sources versus fossil fuels, total consumption, emissions, etc. Surely, all of these new solar and wind projects have caused fossil fuel usage to go down, right? Unfortunately, no. Even the use of coal remains stubbornly high. Outside of a dip in overall energy use in 2020 (during lockdowns), we remain at or near all-time highs in our total need/use of fossil fuels. Fossil fuels still provide over 80% of our world-wide energy.[5] In other words, we still desperately need fossil fuels, and the renewable energy sources don’t seem to have made even a dent in that demand. To be sure, fossil fuel use would be higher without renewable energy, but we’ not going down in total fossil fuel usage.

Fossil fuels are obviously a sensitive political topic. I will leave that discussion to the energy and other experts. But here’s what I know: when people in power are unfriendly to capital, then that capital will go somewhere else where it’s treated better. It’s hard to imagine that energy executives and investors feel comfortable right now committing capital to long-term oil and gas projects knowing that, once the current crisis resolves, they will be on the wrong end of politics again. Add in shortages of labor, sand, and other materials needed to drill, and here we are. Nuclear power also seems to be a sensible carbon-free alternative, but that, too, isn’t getting much love in policy circles.

Therefore, something’s gotta give, and right now it’s the price of energy. Until we get more supply or “demand destruction” (people buy less at a certain price), energy prices will remain elevated. But over the medium to longer-term, technological advances will contribute to solve these problems. Hydrogen from seawater anyone?[6] It’s hard to know which ideas will prevail to solve our energy problems, but the rewards are huge for big breakthroughs – and this always attracts the brightest minds to solve the world’s most vexing problems. It has continuously been this way for the last 250 years.

Some of the Good News I’m Watching

Besides some recent good news on the money supply, here are some further facts to keep in mind. The dollar has recently strengthened, and that’s positive for inflation. The leading economic indicators remain firmly positive.[7] Consumer spending drives the majority of our economic growth, and the consumer overall remains strong – household debt ratios remain near all-time lows.[8] Our employment numbers also remain strong. Supply chains are finally showing signs of easing.[9] China is coming out of lockdown – let’s hope this holds – as this should help further ease supply-chain problems. We remain in growth territory on important manufacturing and services metrics.[10] And S&P 500 company earnings are expected to grow around 9% this year.[11] There is a lot to like here.

None of these facts are meant to convince you that we won’t enter a recession or a deep bear market in stocks. We might. But a normal recession is usually caused by the Fed having to raise interest rates to slam the brakes on excesses created in the private sector. We can’t blame the private sector this time. Rather, loose fiscal and monetary policies have mostly gotten us into this mess. Therefore, my hope is that the private sector holds up better than many anticipate as we work through things.

Conclusion

Expect short-term pain, but we stay invested, we focus on executing our financial plans, and we anticipate continued problems with inflation. And we do not let markets, inflation, the media, or anything else derail our investment strategy. This too shall pass. It’s an election year, so it’s important to be ever more vigilant to discern facts from hyperbole.

As always, I remain confident that our patience and discipline will be rewarded. I am only a phone call away to discuss any concerns or questions you have. Thank you for your continued confidence and trust.

[1]Surveys of Consumers, June 2022[2]S&P 500 Historical Prices by Month, 06/13/2022. And this doesn’t include dividends![3]“Tight” monetary policy would be a short-term interest rate that exceeds the rate of inflation.[4] FRED St. Louis Federal, May 02, 2022.[5] US Energy Outlook Introduction, March 03, 2022. Hannah Ritchie, Max Roser, and Pablo Rosado (2020) “Energy” Our World in Data. Mckinsey.com, April 26,2022.[6] CNBC, October 1, 2021.[7] FRED St. Louis Federal, April 2020.[8] See JP Morgan Guide to the Markets, page 22.[9] NewYorkFederal.org, May 2022.[10] ISMWorld.org, Spring 2022.[11] YRI S&P 500 Earnings Forecast, June 13, 2022.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Marshall Investment Management, LLC, a registered investment advisor. Marshall Investment Management, LLC and Kirsch Wealth Advisors are separate entities from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
The information contained in this email message is being transmitted to and is intended for the use of only the individual(s) to whom it is addressed. If the reader of this message is not the intended recipient, you are hereby advised that any dissemination, distribution or copying of this message is strictly prohibited. If you have received this message in error, please immediately delete.

By |2022-06-14T17:49:58+00:00June 14th, 2022|Uncategorized|0 Comments

It’s Been a Tough Year So Far

“If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” – Warren Buffet, legendary investor and CEO of Berkshire Hathaway

The primary function of financial journalism seems to be terrifying us out of ever achieving our financial goals by shrieking about the market’s volatility. We are being reminded of this daily as some of the major stock indexes are now in “official bear market territory,” which is defined as closing 20% below their previous all-time high. Growth stocks, in particular have suffered the sharpest declines.

Every market decline of this magnitude has its own unique precipitating causes. I think it’s fair to say that the current episode is a response to two issues: severe inflation and the extent to which the economy might be driven into recession by the Federal Reserve’s somewhat belated efforts to root out that inflation by tightening monetary policy. Russia’s war on Ukraine, supply chain issues, China’s Covid lockdowns, and the like have piled on, but recession vs. inflation is the main event in my judgment.

Bonds

If you are in or near retirement, then you should most likely have some bonds in your portfolio. Bonds generally hold up well when stock prices move lower. However, bonds have performed poorly this year, too. According to the Wall Street Journal, bonds are having their worst year since 1842.[1] Yes, that was Eighteen Forty-Two. Interest rates have moved sharply higher this year, and bond prices generally move inversely to interest rates. For many investors, this year feels even worse.

Inflation

Inflation is turning out to be anything but “transitory” – the preferred term used by the Federal Reserve until recently. People generally respond to incentives. And every day that passes, the Federal Reserve is incentivizing people to spend money rather than hold it. Why would you hold money losing purchasing power at 8.5% per year (the rate of inflation) when you are earning next to nothing on it in a savings account? This might work for a while. But without a doubt, something must give here. Either short-term interest rates must rise further (the federal funds rate is .75% to 1.00%)…or inflation needs to come down substantially. And this is precisely what market participants are weighing: will the Federal Reserve significantly increase rates and drive the economy into recession? Or will they tolerate higher inflation for longer? They have a “dual mandate” to achieve stable prices and maximum employment. They are in a tough spot.

Regardless, if we go into recession, then we do. There is clearly excess money in the system. Capitalism is a terrific system that, through recessions, washes away the negative effects of poor decisions by government and private-market participants. We then reset the foundation for firmer economic growth.

Is the News All Bad?

No, it isn’t. In fact, over 90% of companies in the S&P 500 have reported first quarter earnings season, and the results are impressive. According to LPL, 74% of S&P 500 companies beat revenue estimates, 78% beat earnings estimates, revenue grew 13.4%, and earnings grew 9.1%. Obviously, market participants didn’t pay too much attention to these numbers when sending stock prices down, because these numbers are strong. Management teams seem to be figuring out how to work around the myriad labor and supply-chain issues. Without a doubt, some earnings numbers (and estimates) are, to an extent, being artificially increased by inflation. But if earnings and estimates continue to increase, then recession is probably not going to be a near-term event. Therefore, fingers crossed that we’re closer to the bottom of this downturn than the top, but much depends on the Federal Reserve.

Stay the Course

For long-term investors, capitulating to bear markets by selling stocks has generally proven to be a tragedy from which their retirement plans may never recover. Our investment policy is founded on acceptance of the idea that the only way to be reasonably assured of capturing the superior returns of stocks is by riding out their periodic declines. Please remember that since 1980, the average decrease in the S&P 500 is just over 14% in any given year – yet the S&P 500 has been positive in 32 out of those 42 years.[2] You should like those odds. Even the inflationary 1970’s saw the S&P 500 positive in 7 out of 10 years.[3]

My mission continues to give you the best chance of reaching the goals set in your financial plan. And that means staying invested. I cannot insulate you from short to intermediate-term volatility, but I can help you to minimize your long-term regret: the regret that follows from selling your stock positions when they’ve bottomed in price – and then resume their long-term advance, as they always have. I continue to counsel…stay the course.

Are There Any Opportunities in This Mess?

Yes! Roth Conversions – and Roth Conversions. Stock prices are already down substantially, and many people should consider converting funds from a traditional IRA to a Roth IRA – especially for married people whose tax rates are scheduled to remain lower through 2025 under the 2017 Tax Cuts and Jobs Act. When share prices are depressed, you can convert the same number of shares to a Roth IRA for a lower tax cost (due to the lower stock price valuation).[4] Then, ideally, the shares rebound in price inside a Roth IRA, and the funds can later be withdrawn tax-free.

Second, for non-IRA accounts, now is a good time to consider selling some investments that have suffered losses so you can book capital losses that can be used to offset capital gains now and in the future. For the right situations, clients can reap large tax gains by doing this.

Conclusion

I know this has been a painful drawdown in stock and bond prices. And I am acutely aware that it could get worse before it gets better. As always, I’m here to talk through the issues and any anxiety you might be feeling. It is a deep privilege to have earned your confidence and trust. Please stay patient, disciplined, stay invested…and stay focused on the goals in your financial plan.

[1] The Wall Street Journal, 05/06/2022
[2] JP Morgan, 04/30/2022
[3] S&P 500, 2022
[4] Whether it is advisable to convert funds to a Roth IRA depends on many variables, including among other things your current tax bracket, your anticipated future tax bracket, the IRMAA Medicare taxes, and your estate planning goals. Please consult your tax advisor prior to converting any funds to a Roth IRA.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Marshall Investment Management, LLC, a registered investment advisor. Marshall Investment Management, LLC and Kirsch Wealth Advisors are separate entities from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
The information contained in this email message is being transmitted to and is intended for the use of only the individual(s) to whom it is addressed. If the reader of this message is not the intended recipient, you are hereby advised that any dissemination, distribution or copying of this message is strictly prohibited. If you have received this message in error, please immediately delete.

By |2022-05-17T19:23:35+00:00May 17th, 2022|Uncategorized|0 Comments

Inflation to Stagflation?

“When the facts change, I change my mind.  What do you do, sir?”– John Maynard Keynes, British Economist, and pioneer of Keynesian economics.

Until recently, I’ve been an optimist about the direction and impacts of inflation. But two things have caused me to shift my thinking – at least for the near to moderate term. First, the war in Ukraine. Second, the money supply continues to expand at a concerning pace.

Though shifting, the consensus view still seems to be that inflation should subside by year-end as the economy continues to open and supply chain and labor issues resolve. The Fed believes it will be back to near 2% inflation in a couple of years. There is now enough evidence to question this view. Sustained inflation, or perhaps even worse “stagflation” ala 2020’s style, looks like the more probable near-term direction.

Where is Inflation Coming From?

As noted in my last post, inflation is coming from three distinct places: fiscal “stimulus” funds, monetary policy (interest rates and the money supply), and Covid-induced shortages of labor and supply chain disruptions. The consensus view that inflation will moderate goes like this: the fiscal stimulus funds and giveaways are mostly completed[1], the Fed is tightening monetary policy, and the Covid-induced shortages will resolve as we go through the year. Fingers crossed, but I’ve grown skeptical.

We might be mostly complete with the fiscal giveaways, but that money remains in the system (and it’s not all spent, yet). The supply chain problems will eventually resolve – but pessimism is starting to set in around this issue for a timely resolution,[2] and the Ukraine war will pile on here.

The labor issues continue, and there doesn’t seem to be clear answers as to what is causing the labor participation rate to remain stubbornly low. The data is indicating early retirements, relocation to low-cost areas to work remote, fear of catching Covid at work, effects of long-haul Covid, Covid mandates, and daycare issues. In the 1970’s, we had stagflation coupled with a high unemployment rate. It’s easy to imagine that a continued tight labor market could create even more inflationary pressures should we experience stagflation now.

War

The war in Ukraine is clearly affecting energy markets – this is obvious at the gas pump. In addition, Russia and Ukraine are major producers and exporters of grain.[3] Russia is also a major exporter of fertilizer.[4] Expect more pain at the grocery store as food prices rise due to lower yields/supply. And that’s probably just the beginning of markets becoming distorted due to the war. China was already putting pressure on grains prior to the war as they try to rebuild their pig population after African swine fever. In addition, supply chains are being cut in the seas around Ukraine as insurance companies suspend coverage on shipping in these war zones. So in addition to sanctions, the private market acted quickly to cut off supply routes.[5] Western governments undoubtedly will be reviewing their defense budgets, and Europe is now facing difficult decisions on energy. None of this is a positive for inflation.

Money Supply

Adherents of the economist Milton Friedman are called monetarists. Monetarists believe that the money supply directly impacts inflation. As more money is created by the Federal Reserve and the banks, then inflation goes higher (if it’s not offset by real growth). The Federal Reserve, in contrast, doesn’t believe that the money supply is relevant in measuring inflation anymore. According to Jerome Powell, the head of the Federal Reserve, he believes that the link between the money supply and inflation was broken forty years ago.[6] So who’s correct? Given the imprecise nature of economics, it’s hard to say, but the evidence lately has been favoring the monetarists.

The chart below shows the money supply exploding once Covid struck and is continuing to advance 13% per year – it was growing around 6% per year pre-Covid. And the concerning problem is that inflation’s impact on an economy tends to lag the money supply by about 12 to 18 months.

Where Does Money Come From?

Two places: the Federal Reserve and banks. The Fed has been periodically buying massive amounts of bonds beginning with quantitative easing in 2009 (QE for short). QE was originally invoked as an emergency measure back then. But under Ben Bernanke, QE was resurrected as another monetary tool to boost the economy. QE sounds confusing, but it’s rather straight forward. The Fed buys government bonds from private market participants by “keystroking” money into existence (i.e., printing it). This cash infusion into the economy increases the money supply. Money needs to go somewhere, and now we have large amounts of money chasing limited supply and investment opportunities. This is a bit simplified, but you get the idea. The Fed currently has around $9 trillion (that’s a T) of bonds on its balance sheet.[7]

Banks also create money. Let’s say you deposit $100 in your bank account. The bank, of course, wants to make money on your $100. Let’s say they loan $90 to another customer and keep $10 in reserves. The bank just created money…$90 of it. That $90 is then spent into the economy or deposited in another bank (for further loans to be made).

To deter lending (and suppressing the money supply), the Federal Reserve might increase interest rates (reducing people’s willingness to borrow), sell government bonds to the banks (this soaks up excess funds that banks could otherwise loan), require the banks to keep more money in reserves (less money to loan), or pay the bank a higher interest rate to keep funds at the Fed (at some point, the bank will decide that holding funds at the Fed, risk-free, is better than loaning the funds to the public and taking on the risk of the loan not being repaid). So far, the Fed hasn’t done much.

What is the Fed Doing to Combat Inflation?

The Fed just raised short-term interest rates .25% and last November they began reducing the amount of bonds they are buying. But this might not be enough, and the Ukraine War has just complicated their job. If the Fed tightens monetary conditions too much in an inflationary economy awash with money, then we might be rolling out the term “stagflation” – low or even negative real growth with persistently high inflation. Further, a recession later this year or next cannot be ruled out if the Fed feels it must act aggressively to control inflation. But the Fed will be hesitant to act aggressively in an election year. The Fed is theoretically independent, but they don’t want to be blamed for election results.

Sheesh, Is There Any Good News Out There?

Yes, there is. Companies are aggressively investing and adopting technology to improve productivity.[8] Higher productivity is an absolute good in society. It raises our standard of living by contributing real, meaningful growth to an economy while raising wages for workers without contributing to inflation.

According to the St. Louis Federal Reserve, bank lending does not appear excessive[9] while the “velocity of money” is subdued.[10]  Velocity of money is the rate at which money is exchanged in an economy. If these measures remain stable, then that should help contain inflation. Monetarists believe that a higher velocity of money leads to inflation, so even if the expansion of the money supply begins to contract, velocity could pick up as the economy fully reopens thereby prolonging or worsening inflation.

Fourth quarter earnings reports were outstanding, and analyst estimates remain strong for 2022 and 2023.[11]  Excess money in the system should be a tailwind for stocks and support stock prices as we move through the year.

Lastly, if we go into recession, then we do. Capitalism has always been a relentlessly effective system that washes away excesses that result from poor government and private market decisions. Everything resets, stocks are “returned to their rightful owners”, and we start over. I still believe we remain in a long-term “secular” bull market, though, as always, things like geopolitical events could derail that.

Investing in an Inflationary World

While technology can be a powerful disinflationary force, it’s hard to see this force overcoming the severe shock of the Ukraine war to the world economy and the greatly expanded U.S. money supply.[12] If the monetarists are correct and the Fed is wrong on the money supply issue, then the Fed might be in process of committing the policy blunder of a generation.

Stocks generally do well in an inflationary environment, though they might struggle at first. But eventually, well-run companies can raise prices to keep up with inflation. An inflationary environment tends to favor solid companies that have a history of paying rising dividends. Government and high-quality corporate bonds struggle, but commodities generally perform well. Cash is a loser. Gold can also do well, but past results here are mixed. This new inflationary environment will cause investors to reexamine their assumptions, because investments tend to perform very differently across various levels of inflation.

We will remain well-diversified, but there is enough evidence that we should blend in additional defensive measures against inflation. I have added some exposure to commodities, energy, agriculture, utilities, natural resources, and metals in portfolios. I have also added more exposure to companies that have a consistent history of paying rising dividends. And it seemed prudent to add some focus to cyber security firms.

Inflation is deeply destabilizing to economies and always hurts the lower economic classes most. Let’s hope our leaders question all assumptions as they make decisions that affect the lives of so many Americans. And our thoughts and prayers go out to the people of Ukraine and Russia.

It can be difficult to stay invested, and the events of the last couple of years are testing us. As always, we deeply appreciate your continued confidence and trust. Please stay patient, stay disciplined, and stay invested.

[1] CNBC, 12/09/2021. But there remains plenty more to spend. In addition, the $1 trillion infrastructure bill has yet to be spent.
[2] New York Times, 02/01/2022.
[3] Wikipedia, data is for 2020 wheat exports.
[4] World’s Top Exports, 03/08/2022.
[5] Reuters, 03/08/2022.
[6] Reuters, 02/23/2022 and https://www.youtube.com/watch?v=SGNyCOlIEHY.
[7] FRED Economic Data, 03/16/2022.
[8] Bloomberg, 09/11/2021
[9] FRED Economic Data, 03/11/2022.
[10] FRED Economic Data, 02/24/2022
[11] Yardeni Research Inc, 03/14/2022.
[12] Barron’s, 02/04/2022

By |2022-03-18T21:31:30+00:00March 18th, 2022|Uncategorized|0 Comments

Mr. Market Says “Crappy New Year”

The market weakness that we saw last year with growth stocks has now spread to the rest of the market. The S&P 500 entered “correction” territory in January – meaning more than a 10% drop in value. The NASDAQ was worse. So why is Mr. Market in a bad mood?

Corrections are Normal

First, let’s not forget that 10% corrections are normal. Everyone is entitled to a bad mood from time to time. On average, the S&P 500 corrects around 14% each year (and around 11% in years that end positive)[1]. Election years tend to see more corrections, while the price gains tend to happen in the back half of election years. Elections clear up uncertainty, and markets like that. It’s therefore possible that some of this unpleasantness could be with us for a while.

The Federal Reserve

The Federal Reserve has announced that they are going to begin raising interest rates soon. By itself, this is NOT a negative. In fact, it signals that they’re confident the economy is strong enough to withstand higher rates. You wouldn’t know it based on Mr. Market’s attitude in January, but stocks generally do well around these time periods. If the Fed did not act, they would risk creating greater financial instability in the economy because cheap, excess money inevitably finds its way into unproductive investments. In other words, capital is invested in dubious projects – the old “Bridge to Nowhere” – and cheap excess money can also allow price bubbles to form. This eventually leads to much bigger problems. Think housing crisis in 2008. It’s therefore a good thing the Fed is finally acting.

Many market participants are now concerned about the “pivot” the Federal Reserve has made in articulating a more “hawkish” tone on inflation. Jerome Powell’s public appearance on January 26th did not assuage those concerns. The fear is that the Fed might tighten monetary conditions too much and trigger a recession. It’s certainly possible, but this seems unlikely in an election year. The “yield curve” is flattening[2], so the bond market is sending a strong message to the Fed that it might be unwise to raise interest rates too much.

Inflation

Inflation is coming from three distinct places: monetary policy, fiscal policy, and supply issues related to Covid.

The Federal Reserve controls monetary policy principally through short-term interest rates. They have also been buying bonds from the government to fund the federal government’s spending. The feeling is that the Fed is probably a bit late in tightening monetary policy, so now we’re hearing all this tough talk coming from the Fed. Time to start taking our medicine.

The fiscal part of inflation has its roots in the enormous amounts of money pumped into the economy by the federal government that caused the money supply to swell.[3] The money supply is up 41% versus pre-Covid. This is big. Normally, the money supply expands about 6% per year. This money had to go somewhere, and it fueled demand for goods (services, not so much due to Covid). It most likely inflated our house prices, too. But the money supply is normalizing – we’re only up around 13% in the last year. Though there is lag in its inflationary effects, the hope is that as we continue to normalize the money supply, inflation will calm down. We can only buy so much stuff, right?

Then there is the “supply-side” inflation where supply is being crimped by supply-chain bottlenecks and a persistently poor labor force participation rate. The Fed simply cannot do anything about these problems. This is a multi-faceted problem, but it seems that management teams are navigating these issues better than anyone expected.

So What Do We Make Of This?

The monetary and fiscal aspects of inflation are still playing out along with supply-chain issues, the labor participation rate, and Covid. And throw in the Ukraine crisis for good measure. It’s an unsightly mix, so it’s not surprising that we’re seeing volatility.

Corporate earnings, however, ultimately drive stock prices, and earnings forecasts remain strong for 2022 and 2023.[4] And don’t forget the old maxim, “The cure for high prices is high prices.” People adjust. In addition, management teams will do what they’ve always done – they go to work to solve problems. Supply and demand will ultimately converge to get things back in balance.

The economic fundamentals/backdrop remain strong, and stocks tend to do well in a rate-tightening cycle by the Fed. January reminded me of the selloff in the 4th quarter of 2018 – a near 20% drop that lasted into Christmas Eve sparked by Jerome Powell’s ill-advised statements to the press about raising interest rates (he was new on the job). Like then, there are plenty of reasons to suggest that this selloff will be seen as a mere tempest in a teapot – not the beginning of a big bear market drop.

Opportunities

Don’t let Mr. Market’s mood cause you to forget the opportunities caused by market turbulence. If you’ve been thinking of investing some excess cash, this is probably a good entry point for long-term money. Or if you’re considering a Roth conversion this year, now might also be a good time to have that discussion. Lastly, for taxable accounts (non-IRA accounts), it might be wise to think about booking any losses now instead of waiting for year-end.

Thank you for your continued trust and confidence. In the meantime, stay patient, stay disciplined, and stay invested.

[1] https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-the-markets/ see page 16.
[2] https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield The yield curve reflects interest rates from the present out through 30 years.
[3] https://fred.stlouisfed.org/series/WM2NS.
[4] https://www.yardeni.com/pub/yriearningsforecast.pdf.

By |2022-02-01T21:06:20+00:00February 1st, 2022|Uncategorized|0 Comments

General Principles, Current Observations, and a Look at 2021

General Principles

Last year was another good year for investors. The major U.S. stock indexes closed near record highs, but the story was more mixed under the surface. I thought it might be helpful to remember what guides us in our financial planning and investing decisions. As a reminder, here are the general principles you and I are following:

  • You and I are long-term, goal-focused, planning-driven investors. The best course is for us to formulate a detailed financial plan and to build diversified investment portfolios that match the goals in our plans. We do not develop portfolios based on headlines, what’s “hot”, market movements, or some pundit’s view of the economy.
  • Inflation is in the headlines, but stocks historically have been very effective against inflation. Let’s consider stocks starting in 1965. I don’t think we’re headed into this kind of inflation, but the historical comparison might be helpful – and please remember that this was one of the most difficult stretches for stocks in the modern era precisely because of inflation. Earnings per share in the S&P 500 Index were $5.30 in 1965. By 1981, the earnings per share had climbed to $15.18.[1] In words, S&P 500 earnings nearly tripled. Inflation was almost identical over the same period – up just over 3 times.[2] Then the roaring bull market of the 1980’s started, and stocks have trounced inflation ever since.
  • We understand that diversification means investing in a variety of stocks that include small and mid-sized companies, foreign companies – both developed and emerging markets, real estate, bonds, and sometimes commodities. Diversification typically works wonders by helping us stay invested because it smooths out the highs and the lows of investment markets.
  • We believe in continuously acting on a rational plan versus reacting to current events. Unless our goals have changed, there is generally little reason to make significant changes to our investments.
  • We do not believe the economy can be forecast with much precision. Covid was the ultimate example of this. Likewise, investment markets cannot be consistently timed. We’re therefore convinced that the most reliable way to capture the long-term return of stocks is to ride out their periodic drops in value.
  • There are dozens if not hundreds of benchmarks in the investment world. While benchmarking can be important to evaluate a particular fund or strategy, it can easily lead us astray when we compare one to a diversified portfolio – too many benchmarks would be needed. Regardless, the performance of our investment portfolios relative to any given benchmark over an arbitrary time period is ultimately irrelevant to our investment success. You can beat a benchmark but still go broke in retirement. The most important benchmark is our financial plan, which indicates whether we are on track to achieve our financial goals.
  • We always make sure that we have enough cash (and bonds) for near-term expenses not covered by other (retirement) income so that we can more easily ride out the periodic drops in stocks prices.

Current Observations

  • The U.S. economy continues to recover in dramatic fashion. Earnings estimates were continuously revised higher for U.S. companies as 2021 progressed. Frankly, we’ve never seen so many earnings surprises to the upside.
  • The government provided massive monetary and fiscal relief. Reasonable minds might differ on whether the federal government provided too much or the right amount of relief. But the bottom line is that a tremendous amount of money was injected into the economy, and this helped households and businesses navigate through the government shutdowns and the worst pandemic in 100 years.
  • Inflation is proving to be more than “transitory”, and the labor force participation rate remains stubbornly low. It remains to be seen if these trends persist. We now have, in effect, supply-side inflation, and we haven’t seen this since the 1970’s oil embargos. But there is good reason to believe management teams have considerably more control over the current supply problems than we than we did in the 1970s.
  • Inflation has been surprising to the high side, but there are reasons for optimism. First, companies are now spending huge amounts of money to improve productivity[3] – post-pandemic, it’s become clear that companies must innovate and evolve. If successful, this should offset inflation. Second, technology continues to evolve, even accelerating, and technology is inherently disinflationary. Third, we have a declining birth rate and an aging population. Contrast that with the 1970’s when the Baby Boomers came of age and created a large mismatch in supply and demand. These are powerful, structural reasons to believe that inflation will retreat in the next 12 to 24 months.
  • If inflation is as bad as some media outlets claim, then one might wonder why gold hasn’t moved higher, most commodities are off their highs (some significantly lower), bond yields remain stubbornly low, and the dollar remains strong. Speaking historically, these are not inflationary signs.
  • It appears that the tax proposals set forth by the new administration have lost support. Reasonable minds might again differ on whether we need changes to the tax code. As investors, however, some of the proposals that have lost support can be viewed as a positive.
  • Large U.S. stocks had quite a run in 2021, but small and mid-sized companies are now looking quite attractive. The price-earnings multiple for smaller companies has dropped below large companies, and this is unusual.[4] While this is not necessarily a criterion for investing – and it’s certainly not a prediction – diversified portfolios like ours with exposure to small and mid-sized stocks could benefit nicely in 2022.

2021 Overview

Overall, large U.S. companies performed very well in 2021 along with many “value” companies that had been beaten down in 2020. I’m not sure there is ever a “normal” market, but 2021 was certainly not normal given the virus and massive government stimulus. As an example, Macy’s was up 135.38% last year while Amazon struggled to stay positive and was only up 2.38%. Macy’s was thought to be destined for bankruptcy prior to Covid. Many in our industry are calling this the “reopening trade.”

Real estate and commodities also performed very well. Bonds were mixed to negative. And small and mid-sized growth stocks along with foreign stocks had a very tough year, especially late in 2021. We saw hot inflation readings come through late last year, and Omicron piled on by fueling fears that more lockdowns and labor shortages would continue to feed inflation.

The sentiment turned decidedly negative towards many of the smaller growth and foreign companies near year-end. At the risk of getting too technical, inflation that leads to higher interest rates can cause growth stock prices to decline because future earnings are discounted back to present value at a higher rate of interest…in other words, current valuations are less. At least that’s the consensus reason for the turbulence. And higher interest rates could mean higher borrowing costs for these companies. Lastly, I believe that there was a fair amount of selling at year-end for tax positioning, especially among the more innovative and disruptive growth companies that performed so well in 2020 but struggled in 2021.

I sense that many investors could be overreacting to the inflation data. Yes, the inflation readings have surprised to the high side, but traditional readings of other asset classes don’t indicate 1970’s style inflation at this time. Gold, bond yields, and most commodities as mentioned above have all recently been trending down or holding steady. I’ve been humbled by markets often enough to recognize that I could be wrong, but I believe that inflation should settle down as the data points turn more positive in 2022. Despite the recent negative sentiment, the fundamentals appear to be strong in the smaller, innovative growth positions we’re holding, and when sentiment and fundamentals detach, it usually represents opportunity.

Thank you for continued trust and confidence. I am available by phone if you would like to speak. We wish you and your family a Happy New Year!

[1] https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/spearn.htm
[2] See https://www.bls.gov/data/inflation_calculator.htm
[3] https://www.yardeni.com/pub/capspendind.pdf and https://www.economist.com/leaders/2021/05/27/firms-are-rediscovering-their-love-for-capex-good.
[4] https://www.yardeni.com/pub/stockmktperatio.pdf. See Figures 3 and 4.
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By |2022-01-06T22:08:18+00:00January 6th, 2022|Uncategorized|0 Comments
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