Client Newsletter 1Q23
Dear Ambassador Family,
I hope you enjoyed a Merry Christmas and a wonderful New Year!
Let’s dive right in and look at the first quarter of 2023.
Our Strategy is Defensive
As we enter 2023, for now we continue with a cautious bent. The bulls believe the Fed will relent on hiking interest rates in a weaker economy with declining inflation. They also hope either for a mild recession or even a Goldilocks scenario of a Fed cutting interest rates and an economy that has softened, not collapsed, leading way to recovery.
We see problems with this optimistic thesis.
First problem is market valuation. As measured by the S&P 500, investors are paying nearly $20 for every $1 of earnings. We worry they are paying too much: as high as a 35% premium to what it should be worth.
Secondly, the economy is weakening, but not (yet) enough for the Fed to cut rates. It is clear the Fed is closer to the end than the beginning of rate hikes. How many more is an open question. However, if history is a judge, even if the Fed were to cut rates, that does not necessarily mean risk assets should rally immediately.
Third, the rate of inflation is declining – for now. But supply constraints remain in many commodities (metals, agriculture, energy). China stopping COVID lockdowns in the near term means stronger international demand. Wage growth is also high. The Fed knows that if it lets up too soon, the inflation genie might return yet again.
Finally, earnings estimates for companies appear optimistic. Many Wall Street experts predict growth in 23 vs. 22. However, slower economic growth (even if it does not turn negative, which we think is debatable) and falling inflation puts pressure on top line (lower sales volumes) and bottom line (fixed costs, companies slow to lay off headcount). Market valuations on lower earnings might need to reset lower.
Your portfolios are positioned with a healthy level of T-bills with minimal interest rate risk, meaningful coupons, and virtually zero credit risk (US Government). Liquid alternative investments with return/risk profiles less dependent upon market direction are also key components. Equities remain at fairly low exposure. Cash is modest as T-bills offer meaningful yield and ample liquidity if and when it is prudent to rotate into other assets.
Your Strategy Should Be Emotional Clarity
2022 was truly a volatile year.
It was the first year in several when equities declined. 2022 was also the first in many years that both bonds and equities declined together. Investors with portfolios diversified beyond traditional stocks and bonds might have seen benefits to preserve capital for potential future market rallies. They lived to fight another day.
Yet people investing on emotion, not with a disciplined plan, lost.
Some people spent too much time watching screens (television, computer, or iPhone). They got hooked on the latest scheme advertised. They obsessed over greed. That is, until last year.
Once the bear market of 2022 arrived, they went from greed to panic mode. Most of these people lacked long term vision for their nest egg and a prudent Fiduciary advisor to guide them through the storm. Their emotion blinded them, and they sold out at bottoms. They seek short-term market timing rather than long-term planning. Time is their enemy along with their feelings of the day.
Other people forgot about avoiding the trap of “putting all your eggs in one basket.” They pulled their money out not because of lack of opportunity. Rather, they heard about the latest “hot” investment deal (real estate that allegedly “never” goes down?) and plowed their retirement savings into it.
They forgot about 2008-9 (even real estate can go down in value).
Clients who understand and work with us are resilient to the peaks and valleys of the market, popular television pundits, and the temptation to follow emotion. Instead, you have sought out expertise to reflect your own family’s long-term needs and risk tolerance. You have been wise to let us help you in broadening the net of investment opportunities to seek to help you accomplish your goals.
Because of your commitment, your portfolios will do more than just “live to fight another day”.
Tax Changes Are Keeping Us Busy
D.C. always keeps us busy. Of the 2 sure things in life, taxes constantly evolve. Your federal government yet again delivered on that promise.
Congress passed SECURE 2.0, a huge 300 piece of tax legislation. Here are some of the provisions that potentially might impact you the most:
- RMD age for new retirees is delayed to 2023. That means new retirees only have to start taking Required Minimum Distributions when they turn 73. You get to delay when you start paying taxes on your retirement savings if you are a new retiree who does not need the distributions. Lower taxes and more time for your money to potentially grow might benefit you.However, if you are already currently subject to RMDs, you still need to continue taking RMDs.
- SEP and SIMPLE plans now have a Roth option. This means your employer can offer you after-tax contributions to your plan. Contribution limits were increased for most retirement accounts.
- More exceptions to the 10% penalty on early distributions. People who are terminally ill or disaster victims can withdraw money from their retirement assets without paying the extra penalty. However, keep in mind that taking money early from your retirement now might leave you less money for when you actually stop working later. Withdrawals are not tax exempt, plan careful for the amount taken from your retirement accounts.
- Other provisions: lower RMD penalties (10% if IRS deems you forgot to take RMD and corrected in a timely manner) and allowance of rollovers from 529 plans to Roth IRAs.
Come talk to us if you or someone you know needs help in navigating the complexities of taxes.
We Prefer Liquid US Treasuries to Illiquid Bank CD’s
We have fielded a number of questions to the effect of “If the stock market is so bad, why don’t I just stick my money in the bank?”
I always tell my clients to have some money in the bank for current spending needs and a liquidity cushion in case life surprises with unexpected expenses (aka an emergency fund).
However, it’s the money beyond that level which becomes tricky.
To quote from our last newsletter 3 months ago: “For the first time in over a decade, US T-Bills might offer sufficient yield with minimal risk. They now offer a potential tool to diversify investors’ nest eggs.”
We have been investing quite a bit of your investments in short-term US Government T-Bills. This is because we have been cautious about most investments. Additionally, yields at roughly 4.5% are the highest they have been in over a decade.
Why not put it into, say, a bank CD? Well, in many cases, you might have a hard time finding as good a yield (with possible exception of certain “special” CD deals, but buyer beware and read below).
Once you put your money into a bank CD, you have 1 of 2 options. Either keep your money parked there (typically at least 1 year, if not more) if you want to get that interest. Otherwise, if you take it out sooner, you will be assessed a penalty. You might forfeit quite a bit of that interest.
Many annuities are even worse. Not only do they lock your money up for years, but one also has to consider all the fees you pay to get in, stay in, and get out.
On the other hand, T-bills are liquid. If you have a cash need (or if we see better investment opportunity), we can sell out in a matter of minutes. You potentially earn the best of both worlds. If the bear market were to persist, we can continue investing in T-Bills. (Understand that rates are higher now, but that does not guarantee they will stay that way in the future. However, this is also true for banks and annuities.) One potential upside from which you might benefit with us is the opportunity to switch to investments with higher returns without adding excess risk.
Petr Burunov, CFP®
President / Wealth Strategist