What’s Going on in the Markets September 25 2022

The markets finally bounced on Friday afternoon after taking a terrible beating the rest of last week.  On Wednesday, when the Federal Reserve (the Fed) announced another 0.75% increase in short-term interest rates to help battle inflation, this led market participants to conclude that the Fed wasn’t yet close to being done raising interest rates.  And as discussed in our newsletter last week, higher interest rates typically lead to a lower stock market which eventually leads to lower prices for goods and services.

From the way the market is behaving, one might think that some of the world’s largest and most profitable companies are suddenly becoming dramatically less valuable.  Are they all laying off workers, slashing prices, closing factories, and declaring imminent bankruptcy?
 
If all this market action and talk is sending you to anxiously scan the headlines, don’t bother; none of that is happening.  Even as stock prices have fallen, and the Fed has done their best to cool the economy, earnings have grown—a fact that has been routinely ignored by the media.
 
Stock prices have never been a precise indicator of what companies are worth.  They are a very good indicator of what people are willing to pay for their shares at any moment, and right now there seems to be an abundant supply of nervous sellers. There’s little reason to join them if you’re a long-term investor.

Why?  The reasons for bear (down-trending) markets are seldom rational—which, of course, is why bear markets end and stocks return to (and always, in the past, have surpassed) their original highs. 
 
What’s happening right now is not unlike what happens when one of our children is diagnosed with an illness, and the remedy is a daily dose of some awful-tasting medicine.  The illness, in this case, is inflation, which absolutely must be cured if we are to experience a healthy economic life.  Few things are worse than having the money you’ve saved up deteriorate in value at double-digit rates, which is precisely what has been happening this year and will continue to happen if it’s not dealt with.
 
The cure, which any child will tell you is more unpleasant than the illness itself, is the U.S. Federal Reserve raising interest rates, which is one way of reducing the amount of cash sloshing around in the economy.  Rising consumer prices, just like rising stock prices, come about when there is more demand than supply.  Reducing the available cash reduces the number of buyers in relation to sellers (ironically, both in the consumer marketplace and on Wall Street), and eventually slows down the inflation rate to manageable levels. 
 
We can already see how this works in the housing market, where, just a few short months ago, multiple would-be buyers were bidding against each other to pay more than the asking prices.  As mortgage rates have risen, the frenzy has completely dissipated.  The process takes longer in the consumer marketplace at large, but you can bet it’s slowly working behind the scenes.
 
Additional evidence that inflation is cooling can be found in gasoline prices that are solidly below their summer peak levels above $5.00 a gallon, and used car prices, which are normalizing as supplies of new cars on dealer lots are increasing.
 
Doesn’t less spending mean less economic activity?  Doesn’t that lead to a recession?  The answers, of course, are yes and maybe.  But at this point, a recession might not be all that bad for the economy.  Recessions act like a cleansing mechanism, exposing/eliminating waste and inefficiency, ultimately creating a healthier economy when we come out the other end.
 
It’s impossible to know exactly which direction stock prices will go next since stock prices are inherently irrational in the short term. They may rise from here, or go down from here. We know the media’s position will always be one of doom and gloom. Tune them out.
 
I wish I could say that the volatility is over and that we’ve reached bottom.  It’s possible, but it’s more likely that we’ll thrash around the current levels for a few more weeks as we approach the most favorable period in the markets, historically between November and April.
 
Meanwhile, market conditions are heavily stretched to the downside, meaning that we could see a robust snap back this coming week to relieve some heavily over-sold market conditions.  Think of this as your opportunity to unload any losing stocks that have come down so much and have little chance of recovering in the next bull market.  If you’re invested too heavily and have been losing sleep over the current market turmoil, take advantage of the rally to lighten up on some stocks/funds (Disclaimer: this is not a recommendation to buy or sell any securities. Please consult with your own financial advisor or talk to us).
 
I can’t rule out that the markets test lower levels in the weeks ahead; in fact, they likely will. But eventually, this bear market shall come to an end and a great buy point will emerge with a new bull (uptrending) market.
 
For our client portfolios, we took additional defensive action this past week and plan more defensive action in the coming week, depending on the weight of evidence presented by any coming bounce in the markets. If you’re managing your own portfolio, consider whether your own invested percentage is consistent with your risk tolerance and adjust it if you think your portfolio risk level is too high.
 
For now we’re taking our medicine, and boy, does it taste awful.  We are also, collectively, suffering an economic illness.  Anybody who has come down with a bug and taken medicine to cure it knows that the former unpleasantness doesn’t last forever, and therefore neither does the latter.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: https://www.nytimes.com/2022/05/14/business/inflation-interest-rates.html

Federal Student Loan Forgiveness and Delayed Repayment to 2023

On August 24, 2022, just a few days before federal student loan repayment was set to resume, President Biden announced a plan for additional student loan debt relief.

Federal student loan repayment was originally halted in March 2020 at the start of the pandemic. The new plan: 1) Extends the payment moratorium through the end of the year; 2) Offers partial debt cancellation; 3) Includes proposed updates to the Public Service Loan Forgiveness program and 4) Introduces a new income-based repayment plan.

What's new

Here’s the new framework for federal student loans:

Loan Cancellation. The plan will cancel $10,000 of federal student loan debt for borrowers with an adjusted gross income less than $125,000 ($250,000 for married couples filing jointly). The loan cancellation increases to $20,000 for borrowers who are Pell Grant recipients (1) (a Pell Grant is a federal financial aid grant award to students from low-income households.) Eligibility is based on income from 2020 or 2021, but not 2022.(2)

The Department of Education estimates that 21% of the borrowers eligible for relief are 25 years and younger, 44% are ages 26 to 39, and the remaining 35% are ages 40 and up, including 5% who are senior citizens. The Department also estimates that approximately 27 million borrowers (more than 60% of the borrower population) are Pell Grant recipients and will be eligible to receive up to $20,000 in debt relief. (3).

Payment Pause Extended: The pause on federal student loan repayment is being extended one "final" time through December 31, 2022. President Biden's announcement states that "borrowers should expect to resume payment in January 2023."(4) In practice, borrowers should expect to hear from their loan servicer at least three weeks before their first payment is due.

Changes  to the Public Service Loan Forgiveness (PSLF) Program: Borrowers who are employed by a nonprofit organization, the military, or the government may be eligible to have their federal student loans forgiven through the PSLF program due to time-sensitive changes. These temporary changes waive certain eligibility criteria for the program and make it easier for borrowers to receive credit for past periods of repayment that would otherwise not qualify for PSLF. These changes expire on October 31, 2022.

Important note: Borrowers who might qualify for loan forgiveness or credit under the PSLF program due to these time-sensitive changes must apply to the program before October 31, 2022. Borrowers can visit the administration's PSLF website for more information.

In addition, the Department has proposed allowing certain kinds of deferments and forbearances, such as those for Peace Corps and AmeriCorps service, National Guard duty, and military service, to count toward PSLF.

A New  Income-based Repayment Plan. The Department of Education is proposing a new income-driven repayment plan that does the following:

• For undergraduate loans, caps monthly payments at 5% of a borrower's discretionary income (currently borrowers must pay 10% of their discretionary income)
• For borrowers with original loan balances of $12,000 or less, the loan balance would be forgiven after 10 years of payments (currently borrowers must repay their loans for 20 years)
• Raises the amount of income considered non-discretionary, with the result that a borrower who earns an annual salary based on a $15 minimum wage would not have to make any payments (the monthly payment would be calculated at $0)
• Covers a borrower's unpaid monthly interest, so that a borrower's loan balance won't grow due to interest as long as the borrower is making monthly payments (under current income-driven repayment plans, a borrower's loan balance can grow even if the borrower continues making monthly payments, because the interest keeps accruing)
• Makes income recertification automatic, which will allow the Department of Education to automatically retrieve a borrower's income information every year instead of making borrowers recertify their income annually

Will my loans be cancelled automatically?

For most borrowers, no. The Department of Education will be creating a "simple" application for borrowers to claim relief, which will be available by early October. Borrowers who would like to be notified when the application is open can sign up on the Department's subscription page. Once borrowers complete an application, their loan cancellation should be processed within four to six weeks. The Department recommends that borrowers apply before November 15 in order to receive loan cancellation before the payment pause expires on December 31, 2022. (The Department will still process applications even after the pause expires.)

Some borrowers, however, may be eligible to have their loans cancelled automatically because the Department already has their income data on record.

Are current students eligible for loan cancellation?

Yes, current students are eligible for loan cancellation, provided their loan was obtained before July 1, 2022. However, borrowers who are dependent students need to qualify based on parental income, not their own income.(5)

Are  graduate students eligible for loan cancellation?

Yes, provided income limits are met and it is a federal loan, such as a Direct Loan or Grad PLUS Loan. Private loans are not eligible.

Do parent PLUS Loans qualify for cancellation?

Yes, provided the income limits are met. Any private loans taken out by parents to pay their child's college education are not eligible.

Will I be taxed on my cancelled debt?

At the federal level, no. At the state level, maybe. Any student loan relief will not be treated as taxable income at the federal level, thanks to provisions in the American Rescue Plan Act of 2021. However, a handful of states that have not yet aligned their laws with this Act could still tax the amount of student debt forgiven unless they act to amend their laws and affirmatively exclude this debt.

I have more than $10,000 in student loan debt. Will my monthly payment be adjusted after cancellation?

It depends. Borrowers who are already in an income-driven repayment plan generally won't see their monthly payment change because their payment is based on their discretionary income and household size, not their outstanding loan balance. By contrast, borrowers who are in a fixed payment plan should have their monthly payment recalculated by their loan servicer because their outstanding balance will be lower after loan cancellation, which should result in a lower monthly payment.

I made monthly payments during the payment pause. Can I still qualify?

According to the Department of Education, borrowers who continued to make payments on their federal student loans after March 13, 2020 will still qualify for loan cancellation (assuming they meet the income guidelines). Borrowers can request a refund by calling their loan servicer directly. According to Mark Kantrowitz, a financial aid and student loan expert, only 1.2% of borrowers continued to make payments during the payment pause.(6)

If you would like to review your current investment portfolio or discuss any college planning or loan repayment matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

(1) U.S. Department of Education, 2022

(2) The New York Times, August 25, 2022

(3-5) White House Fact Sheet, August 24, 2022

(6) The Wall Street Journal, August 25, 2022

Some Cures For Your “Social InSecurity”

Some Cures For Your “Social InSecurity”

 One of the most common questions I hear from clients and prospects concerns the viability of the social security system and the likelihood it will be solvent enough to pay their benefits when they eventually reach retirement age. Their default instinct is to draw social security at the earliest possible age in case benefits were to run out prematurely. As you’ll read below, the Social Security program has many possible tweaks to help extend the payment of benefits for many decades to come and should help alleviate much of your Social InSecurity.

With approximately 94% of American workers covered by Social Security and 65 million people currently receiving benefits, keeping Social Security healthy is a major concern. According to the Social Security Administration, Social Security isn't in danger of going broke — it's financed primarily through payroll taxes — but its financial health is declining, and future benefits may eventually be reduced unless Congress acts.

Each year, the Trustees of the Social Security Trust Funds release a detailed report to Congress that assesses the financial health and outlook of this program. The most recent report, released on June 2, 2022, shows that the effects of the pandemic were not as significant as projected in last year's report — a bit of good news this year.

Overall, the news is mixed for Social Security

The Social Security program consists of two programs, each with its own financial account (trust fund) that holds the payroll taxes that are collected to pay Social Security benefits. Retired workers, their families, and survivors of workers receive monthly benefits under the Old-Age and Survivors Insurance (OASI) program; disabled workers and their families receive monthly benefits under the Disability     Insurance (DI) program. Other income (reimbursements from the General Fund of the U.S. Treasury and income tax revenue from benefit taxation) is also deposited in these accounts.

Money that's not needed in the current year to pay benefits and administrative costs is invested (by law) in special government-guaranteed Treasury bonds that earn interest. Over time, the Social Security Trust Funds have built up reserves that can be used to cover benefit obligations if payroll tax income is insufficient to pay full benefits, and these reserves are now being drawn down. Due to the aging population and other demographic factors, contributions from workers are no longer enough to fund current benefits.

In the latest report, the Trustees estimate that Social Security will have funds to pay full retirement and survivor benefits until 2034, one year later than in last year's report. At that point, reserves will be used up, and payroll tax revenue alone would be enough to pay only 77% of scheduled OASI benefits, declining to 72% through 2096, the end of the 75-year, long-range projection period.

The Disability Insurance Trust Fund is projected to be much healthier over the long term than last year's report predicted. The Trustees now estimate that it will be able to pay full benefits through the end of 2096. Last year's report projected that it would be able to pay scheduled benefits only until 2057. Applications for disability benefits have been declining substantially since 2010, and the number of workers receiving disability benefits has been falling since 2014, a trend that continues to affect the long-term outlook.

According to the Trustees report, the combined reserves (OASDI) will be able to pay scheduled benefits until 2035, one year later than in last year's report. After that, payroll tax revenue alone should be sufficient to pay 80% of scheduled benefits, declining to 74% by 2096. OASDI projections are hypothetical, because the OASI and DI Trust Funds are separate, and generally one program's taxes and     reserves cannot be used to fund the other program. However, this could be changed by Congress, and combining these trust funds in the report is a way to illustrate the financial outlook for Social Security as a whole.

All projections are based on current conditions and best estimates of likely future demographic, economic, and program-specific conditions, and the Trustees acknowledge that the course of the pandemic and future events may affect Social Security's financial status.

You can view a copy of the 2022 Trustees report at ssa.gov 

Many options for improving the health of Social Security

The last 10 Trustees Reports have projected that the combined OASDI reserves will become depleted between 2033 and 2035. The Trustees continue to urge Congress to address the financial challenges facing these programs so that solutions will be less drastic and may be implemented gradually, lessening the impact on the public. Many options have been proposed, including the ones listed below. Combining some of these may help soften the impact of any one solution:

• Raising the current Social Security payroll tax rate (currently 12.4%). Half is currently paid by the employee and half by the employer (self-employed individuals pay the full 12.4%). An immediate and permanent payroll tax increase of 3.24 percentage points to 15.64% would be needed to cover the long-range revenue shortfall.
• Raising or eliminating the ceiling on wages subject to Social Security payroll taxes ($147,000 in 2022).
• Raising the full retirement age beyond the currently scheduled age of 67 (for anyone born in 1960 or later).
• Raising the early retirement age beyond the current age of 62.
• Reducing future benefits. To address the long-term revenue shortfall, scheduled benefits would have to be immediately and permanently reduced by about 20.3% for all current and future beneficiaries, or by about 24.1% if reductions were applied only to those who initially become eligible for benefits in 2022 or later.
• Changing the benefit formula that is used to calculate benefits.
• Calculating the annual cost-of-living adjustment (COLA) for benefits differently.

A comprehensive list of potential solutions can be found at ssa.gov.

As for when Congress will act to fix the system, in my opinion, it will probably be at the last minute when it becomes a crisis. But make no mistake-Congress will act, and any rumors or stories that social security won’t be around for the long term are simply false. Any member of Congress who votes against fixing and extending the system’s heath won’t be re-elected, and therefore you know they eventually will.

As for when you should consider drawing your own social security benefits, the unsatisfying answer is: it depends. Whether you should draw benefits at your early retirement age (usually 62), full retirement age (usually 67) or latest retirement age (70), depends on your financial situation, your spending needs, expected longevity and other factors. Only working with a financial planner or a comprehensive social security optimizer can help you figure out the optimal timeframe to claim social security. The right or wrong decision can increase or decrease your lifetime benefits by five or six zeroes---it’s worth the time and effort to do the analysis. We can, of course, help.

If you would like to review your current investment portfolio or discuss your social security benefits, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

What's going on in the Markets June 20, 2022

With ten days to go in the 2^nd calendar quarter and the end of the first half of 2022, we’ve witnessed one of the worst yearly starts in the markets since 1962 with a decline of about 23% in the S&P 500 index. This makes this year the 3^rd worst start for the index in market history.  

The good news? Of the fourteen other worst starts to the year since 1931, ten of them went on to turn in positive returns for the rest of the year, although only five of those fourteen years turned things around and closed with positive returns for the entire year.

Mid-term election years (the 2^nd year of a president’s term) have historically been lackluster, but that doesn’t entirely explain why this year has been so awful. Of course, the same culprits outlined in my What’s Going on in the Markets May 8, 2022 newsletter are still front and center today: 1. The war in the Ukraine; 2. Rising inflation; 3. Higher interest rates. A resolution in any of these three culprits could send the markets on a big trek higher.

To be fair, the markets were rife with speculation in all manners of stocks, special purpose acquisition companies (SPACs), initial public offerings, crypto-currencies, non-fungible tokens (NFTs) and other insane valuations of art, homes, antiques, etc. Most of this rampant speculation was fueled by the unprecedented fiscal and monetary stimulus unleashed in the markets by the Federal Reserve and Federal Government to combat a potential economic depression caused by COVID-19. As happens most often, a pendulum that swings too far in one direction must swing too far in the other direction to correct the excess. That’s the nature of cycles-both economic and markets.

From the pandemic low in March 2020 to the high in January 2022, the S&P 500 index more than doubled (+108%), so a market that moves that far in less than two years would historically be expected to give back (retrace) some of those gains at some point. To most students of long-term markets, giving back 50% or more of those gains would not be unusual at all before the uptrend might resume. At a closing level of about 3,678 as of last Friday, that would take the S&P 500 index to around 3,500, about 5% lower than Friday’s close. Nothing says it must stop there, but that level historically would be expected to generate at least a decent bounce or short-term rally.

Adding insult to injury, this has also been one of the worst starts in over 40 years in the bond markets. Long adding ballast to portfolios and a relative haven from the stock market storms, bonds on average are down over 12% year-to-date, with long term treasuries down over 24%. Even 1–3 year treasury bills are down about 3.7%, making even the safest and shortest of duration government bonds not immune from the carnage. Of course, when bond prices decline, their yields increase, so they become more attractive for new investments.

The perfect storm of a bond and stock market decline means that there have been few places to hide, other than energy and commodity stocks. Of course, energy and commodity stock outperformance mean higher prices for goods, which is at the heart of the inflation problem we now have.

Inflation Marches Higher

When so much stimulus enters the economy and markets in a short time, inflation inevitably rears its ugly head. Think of fiscal and monetary stimulus as money printing, and you can quickly understand how adding so many dollars to the money supply would tend to de-value those dollars. Indeed, when the inflation numbers were released for April and May (8.6% and 8.4% consumer price index respectively), they were higher than expected.  Relief in the supply chain logjam was not enough to offset the increased cost of labor, energy, and commodities (mostly raw materials and foodstuff).

Obviously, inflation at this level cannot be sustained longer term and needs to be tamed before it crashes the economy as consumers begin having trouble affording necessities, let alone discretionary purchases. It’s one of the two mandates of the Federal Reserve (The Fed): to reel in inflation using the tools at their disposal to prevent an economic crash.

Interest Rate Hikes

The dual mandates of The Fed are to:

1. Maintain price stability (by keeping inflation to 2% or less) and,

2. Ensure maximum employment.

With unemployment at historic lows, maintaining price stability is currently job #1 for The Fed.

When the pandemic hit, you may recall that The Fed immediately reduced short-term interest rates from 2.25% to 0% to counter the expected economic contraction effects of the COVID-19 pandemic. They also launched one of the biggest asset purchase plans (bond buying) in history as an emergency measure to ensure enough liquidity in the financial system to keep the economy and commerce from seizing up. The Fed kept these asset purchases up through March of this year (far longer than necessary in my opinion), thereby flooding the markets with stimulus.

Beginning in April, The Fed raised short term interest rates by 0.25% for the first time and announced that the bonds bought over the past several years would be sold off over time. Of course, if injecting the markets with all that stimulus and maintaining low interest rates props the markets up, withdrawing that liquidity and raising interest rates should have the exact opposite effect--and of course it has.

The Fed followed up with a 0.5% and 0.75% short term interest rate hike in May and June respectively, bringing the short-term rate to around 1.5%. During the June meeting, The Fed telegraphed that a further 0.5% or 0.75% interest rate hike could be forthcoming in July (and future months) if inflation doesn’t ease in the coming month. Of course, with inflation running over 8%, The Fed, with short term interest rates around 1.5%, is still woefully behind the curve. Many pundits and critics want them to move much faster to tame inflation.

Low interest rates (near 0% for over two years) represent “cheap money” to individuals and companies, encouraging investment, spending, borrowing, and of course speculation. All of that tends to make for an overheated economy, pushing prices higher. Raising interest rates tends to curb the demand for capital and overall spending, thereby reducing pressure on the supply of goods and services, and in turn, reducing pressure on prices. But by doing so, The Fed risks pushing the economy into a recession.

Recession or Soft Landing

The Fed has acknowledged that lifting interest rates may curb consumer and corporate demand enough to push the economy into a recession. Fact is, it’s possible that we’re already in a recession but don’t know it yet.

The textbook definition of a recession is at least “two consecutive calendar quarters of negative gross domestic product or GDP.” For the first quarter of 2022, the economy did register a negative GDP of 1.3%, and the second quarter could potentially register a similar small negative GDP. As of Friday June 16, the Atlanta Federal Reserve lowered GDP estimates for the 2^nd quarter to about 0%, which means that it could easily turn negative by the end of the quarter, putting us into a an official recession.

Regardless of how the 2^nd quarter plays out, textbook recession or not, I would expect that any recession would be another mild or short one (like the short-lived COVID recession of 2020) as we try and squeeze out much of the excesses brought on by the post-COVID over-stimulus. While you’re likely to be bombarded (and scared witless) by the news media about how the economy has officially fallen into a recession, it remains to be seen how long and how bad it might get. With housing and employment still strong, and corporate earnings holding steady, (albeit weakening somewhat with everything else), the recession should prove to be mild or moderate in my opinion.

What To Do Now

The market is currently in what I would characterize as “no-man’s land”. That’s to say that it’s too late to sell and yet probably too early to buy. As mentioned above, we have the potential to visit the 50% retracement level of S&P 500 at 3,500, 5% lower from here. But the selling was so intense last week, that could be considered somewhat exhaustive, or capitulatory as some refer to it in the business. While bad things tend to get worse in the markets before they get better, the proverbial rubber band to the downside is firmly stretched, meaning that a strong snapback rally could start as early as tomorrow, if not later this week or next.

In a mid-term election year, we tend to see a summer rally from late June into mid-July, with weakness or sideways movement persisting throughout the August-October period. But post-election, a year-end relief rally into the spring tends to be strong. So unfortunately, any relief rally in June/July may prove fleeting, with much better probabilities for a long-term rally coming in the 4^th quarter. Of course, this is all crystal ball prognostication, relying on history to project future returns. This should not be relied on to make investment/portfolio decisions.

So, what about nibbling at stocks and stock funds (and even bonds) with the market down so much? While dollar cost averaging over time has a successful track record, the key is your own personal discipline to continue investing at regular intervals and knowing that it may take months or years to become profitable on new buys, especially if this market doesn’t find a bottom until late this year or next.

Those who bought in mid-2008 thinking that the bottom was in found out that they had to endure another 30% drawdown until the ultimate bottom in March 2009. In the end, this all turned out great for long term holders, albeit with a little pain.

If you are confident that you won’t sell everything if the market continues lower and reach your own capitulation point, there’s nothing wrong with nibbling on names that have come down to attractive levels. Personally, I prefer to see signs of strong demand returning from large institutions, something that is still absent at these levels. The path of least resistance, as of today, is unfortunately lower, but that could easily change in a day or two of strong buying.

For our client portfolios, we came into the 2^nd quarter with one of our lowest allocations to stocks and bonds in years. We continue to be hedged with cash, stock options and bear market funds, and we continue to harvest profits and raise cash. If we see further weakness and no return of demand from institutions, we will further increase our hedges and continue to sell underperforming positions into any rallies that “peter out” in short order.

If you find yourself stuck in positions that no longer meet your initial criteria for buying them in the first place, consider using upcoming rallies to sell them (even at a loss) and upgrade your portfolio with better performing companies at the right time. Instead of big bites, take little nibbles, and keep in mind that bear market rallies are very good at sucking in investors and convincing them that the selloff is over, only to roll over and make lower lows. This is not a recommendation to buy or sell any security.

No one knows how deep the market will pull back. Have we seen the lows, or do we have some ways to go? I personally think we may have seen the worst of it, but that’s just a gut feeling. That doesn’t mean that I believe that the sell-off is over. Similarly, we have no idea if the next rally will mark the bottom of this pullback or just be another “suckers’ rally”.

In the end, these somewhat painful periods always end, paving the way for a new long-term uptrend (a.k.a., a bull market). As I always echo, investing in the stock market is great for long term returns, as long as you don’t get scared out of it at the wrong time. After all, enduring volatility is the price we pay for outsized long-term returns. Be patient and stay small with buys to keep your risk in line with your own tolerance.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

What’s Going on in the Markets May 8, 2022

It was another down week in the stock markets, which, under the surface, was worse than the Dow Jones Industrial Average and S&P 500 indexes being down only about 0.25% might have suggested. Volatility continues to rule the markets daily as investors and traders try to discount the effects of inflation, interest rate hikes, a raging war, and the possibility of a recession in the coming months.

Speaking of interest rate hikes, the Federal Reserve (The Fed) met last week and raised short-term interest rates by 0.5% (bringing them to 0.75%-1.00%). The Fed signaled that more 0.5% interest hikes were likely coming and also mentioned that single day 0.75% hikes were not being considered. Although the markets breathed a sigh of relief on Wednesday and rallied about 3% from the day’s lows, that rally was short-lived as the markets gave it all back and more on Thursday and Friday.

As of Friday's close, the S&P 500 index is down about 13.5%, while the harder-hit tech-heavy NASDAQ is down about 22.3% year-to-date. Those figures, however, don't reflect the level of carnage under the surface, where some growth stocks are down as much as 80% from their prior peaks. Strength in the markets is found in energy stocks (where oil prices continue to float above $100 a barrel) and defensive stocks (consumer staples, some healthcare, and utilities).

Even bonds, long known to provide ballast to stocks, are down about 11% year-to-date and have not held up their end of the bargain. Bonds are having one of their worst starts to the year since the 1970s. Even if you're hiding out in 1–3 year short-term treasury bonds, you're still down about 3.1% since the beginning of the year. The typical 60/40 (stock/bond) portfolio has provided no shelter from the recent market storm.

When you see both stocks and bonds down in tandem, the usual culprit is an inflationary environment. Last month's government report on inflation, the Consumer Price Index (CPI), showed inflation rose 1.2% in March, translating to an annualized rate of 8.5%. This coming Wednesday, we get the read on April inflation, which should see inflation easing from March levels (based on reports of declining used car prices, lower demand for homes, and supply chain improvements).

The Fed has two core mandates as its mission: 1) keep unemployment low and 2) maintain price stability.

At this point, The Fed has no choice but to raise interest rates to try and tame the inflation beast. Unfortunately, raising short-term interest rates has the side effect of slowing economic activity because capital becomes more expensive for both consumers and companies, thereby forcing a slowdown of discretionary purchases and capital improvements (and stock buybacks, which buoy the markets). We are already seeing a slight easing in housing market pressures as 30-year mortgage rates tick above 5%.

Inflation at the current rates is simply not tenable, and therefore The Fed must do what it can to keep the prices of goods and services at prices that consumers can afford.

Further taming of the inflation beast with short-term interest rate hikes can sometimes cause such a slowdown in the economy that we see negative growth in the gross domestic product (GDP), as was reported in the 1^st quarter of 2022 when GDP unexpectedly contracted by 0.4% (which is an annualized rate of 1.4%).

As of the end of the 1^st quarter, we had only experienced a single 0.25% short-term interest rate hike by The Fed, so that was not the proximate cause of the decline in GDP. More likely, the side effects of the ongoing war in Ukraine, a complete lockdown in parts of China because of COVID resurgence, and inflation worries all weighed on the economy in an otherwise environment of robust consumer demand.

The definition of an economic recession is two consecutive quarters of contracting GDP, so 2^nd quarter 2022 GDP is pivotal in determining whether we’re already in an economic recession. Perhaps that’s what has the markets worried.

Also on the economic front, both the Institute for Supply Management’s (ISM) Manufacturing Index and the ISM Services Index remained at high levels last month; however, there is some weakness developing under the surface. The ISM Manufacturing Index has fallen in five of the last six months, while new orders for the services sector fell to a 14-month low. At the same time, prices have remained stubbornly high in both indexes, which raises the possibility of economic stagflation (inflation + slowing economy) in the coming months.

What About Now?

While the markets continue their correction (pullback), we have continued to get more defensive in our client portfolios by selling more (underperforming) positions, adding to our hedges, and tightening up our option selling. Unfortunately, in a rising volatility environment, the fruits of our option selling labor don’t begin to show up in client portfolio results until after the volatility subsides, or those sold options expire. That doesn’t mean we won’t continue to allocate to those strategies to reduce portfolio risk, but in the short term, they may not display the intended positive portfolio effects.

While I don’t have a working crystal ball, I’ve seen little evidence that the volatility is about to subside anytime soon. Though the markets are oversold (stretched to the downside) on a short-term basis, we have not seen any bounces that have lasted longer than a day or two, at least not since late March. We are certainly overdue for a robust bounce that lasts at least a few weeks or months, but I don’t see any evidence to believe that we’re at a durable long-term bottom yet.

Therefore, this back-and-forth choppy action may continue until after the mid-term elections, as is typical for this part of the presidential cycle. We may also need to shake out more weak hands in the short term and get to some level of capitulation or panic in order to get a sustainable rally.

One contrary indicator, investor sentiment about the markets, is at some of the lowest levels--some levels on par with sentiment during the great financial crisis in 2007-2009 and the COVID crisis, hinting that investors are not very exuberant about investing in the markets. Another contrary indicator, mutual fund flows, shows that investors of late are cashing out of stocks in recent weeks, which means at some point, many will be forced to buy back their stocks in the near future.

If you’re not a client of ours, I hope you have taken some action with your portfolio during the prior market rallies, to reduce your overall risk and exposure to the stock market. Whether selling some underperforming positions, buying some bear market funds, or just hedging your portfolio in one way or another, figure out a way to reduce your overall portfolio risk. Don’t wait until the market is down a lot before taking some action. You want to have some cash on hand to pick up some “bargains” once the market resumes its uptrend.

If you have not, or if you still feel overexposed, you should consider doing so during the next market rally to bring your portfolio more in line with your own personal risk tolerance. This is especially true if you find yourself worried about your investments more than usual these days. Remember, no one can control what the market does, but you and only you can control the risk you’re taking and the amount of the loss you wish to sustain. If you’re picking up anything on this downturn, keep it small and expect that you’ll have to wait some time to become profitable on these positions. Disclaimer: None of the foregoing should be construed as investment advice or a recommendation to buy or sell any security. Please consult with your own financial advisor or talk to us if you need help.

In a rising interest rate environment where inflation is not yet under control, and where The Fed is now a net seller of bond assets (instead of a buyer), stocks will have a hard time making it back to old highs, not to mention making new ones. While the 13-year-old bull market may not be finally dead, I don’t see this environment as friendly to investing as it has been in the recent past. Don’t assume that the “beach-ball” market that absorbed all manner of “meme stocks”, special purpose acquisition companies (SPACs), Ponzi stocks, a flood of IPOs, and additional stock offerings is going to come roaring back, because I don’t believe that it will anytime soon. Remember, if your favorite stock is down 50%, you need it to double just to get back to even. I don’t think you can count on that anytime soon either.

There’s a saying in the investing world that most have heard: “Don’t Fight The Fed.” That means when The Fed is accommodative with low-interest rates and is actively providing liquidity to the markets (as they mostly have for the past 13 years), you’re essentially investing with the wind at your back. In that environment, you want to be a net buyer, not a net seller of securities.

If you believe that saying is true during the accommodative periods, then trying to fight the Fed when they are withdrawing liquidity and raising interest rates and insisting that the market should go up in the face of those headwinds would not make much sense during the non-accommodative period we’re experiencing right now.  A time of Fed accommodation will return at some point but be patient and cautious with new investments until then.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.