Client Newsletter 4Q22
Dear Ambassador Family,
2022 has been a momentous year! It has reminded us that investments do not just travel in one upward direction.
We will discuss how we see things near and longer term. In short, we still lean toward playing defense, though we could see temporary reprieve in the markets.
We have emphasized defense, especially this year, because this is not just your money. Your nest egg is a source of funding your retirement income, future dreams, and health care costs in retirement. While we seek ways to grow your assets and find income, we also keep an umbrella on hand for rainy days – like 2022, maybe a little longer.
If you have other investments that might benefit from this approach, please come talk to us. If you know someone who feels a little beat up after 2022 and needs some help, have them give us a call.
We are here to help.
Enjoy the Bear Market Rally While It Lasts…
Near term, we could see a mild bounce in the markets. Markets experienced a sharp -15% decline from mid-August to mid-October. Markets since then have shown mild resilience.
Seasonality, hopes for an end to Fed rate hikes, and options speculation might allow for a temporary bounce. 3rd quarter earnings and macroeconomic data are a wild card.
While we have modestly taken up risk, we see it only as a tactical bounce over which major headwinds remain. We would expect to take it off at higher levels perhaps toward the end of the year.
…But Serious Risks Still Remain.
Our medium-term concerns about risk assets remain:
- Inflation continues to remain an issue.
- Commodity scarcity: in spite of higher prices, supply in most commodities is not rising. OPEC+ is cutting 2 million barrels of production, the US Strategic Petroleum Reserve will soon run out of barrels, and diesel inventories in the US are less than 30 days of supply, near all-time low. Food harvests and rare earth (used in renewable energy) are also supply-constrained.
- Labor wage hikes are passing through the system. This in past cycles has been the real driver in times of stubbornly high inflation. Railroad engineers, airline pilots, and other industries have received double-digit wage increases.
- The question is not necessarily whether inflation near-term has peaked, but rather where will inflation plateau. Consensus expectations call for inflation to drop only to 5% next spring from over 8% currently. (Bulls need inflation to fall to 2%. Given supply shortages and government spending, we are concerned that hope might be too optimistic.)
- Interest rates remain an overhang:
- Short and long-term interest rates hover at +/-4%, the highest in over a decade. In the meantime, the Fed is still catching up.
- The bulls expect the Fed to “cry uncle” similar in 2018-9. In a matter of months, the Fed shifted from raising to cutting rates due to fears of economic recession. The stock markets rallied.
- What is different today 2018 is that inflation and fiscal spending are both much more serious issues.
- If the Fed stops raising or even cuts rates, it runs the risk of a new inflation surge. Markets might like it initially, but at some point, we fear the rally would end as investors realize the inflation genie is out of the bottle.
- If the Fed keeps on going, we risk seeing deflation in the form of price declines in financial markets.
Other Issues Include:
- Retail investor sentiment (what they really do, not what they say) is still elevated. BofA investors still maintain high allocations to stocks versus history (and well above pre-pandemic).
- Corporate earnings are subject to disappointment and reduction (margin pressure, demand weakness). Transport companies, a barometer for the overall economy, have warned about declines in volumes entering the holiday season (and the stocks have suffered). Wall Street still expects earnings growth in 2023 despite signs of a weaker economy. We believe this is overly optimistic.
- The surging US Dollar has not only driven debt costs higher for emerging markets, but also has pressured large developed market currencies (UK, Japan). Markets fear a violent spiral in devaluation might also take their toll on assets held in the US.
- Geopolitical risk (Ukraine, Taiwan) is another wild card.
If You Are Fully Retired
- Social Security and Supplmenental Security Income (SSI) benefits will rise +8.7% in 2023 starting January.
- Medicare Part A and Part B Premiums will be decreasing by 3% in 2023.
If You Are Still Working
- The inflation-adjusted maximum amount of earnings subject to Social Security tax will increase to $160,200.
- If you took early Social Security and are working part time prior to full retirment age (FRA), earnings limit will increase to $21,240 before penalties will apply.
How We Intend to Navigate This Landscape
Exiting the bull market of last year, we believe a prudent investment posture consists of 2 stages in the current environment.
Stage 1: “Play Defense.”
For 2022, we have focused on reducing downside risk. We had entered the year moderately cautious on equities, and extremely cautious on fixed income (down over -15%, the worse year in decades). Cash, large cap equities, and diversified strategies have been our main focus.
Stage 2: “Go Back on Offense, But Be Careful.”
Timing is uncertain (it might take months or even years). Markets and economic fundamentals will show true signs of bottoming. The Fed might finally be able to cut interest rates. Perhaps a systemic failure (a major bank or country) is needed to wash out markets. At that point, we would begin to see some true value, especially in traditional assets. Perhaps we might invest again in foreign markets (which have been major underperformers this decade).
The Newest Investment Is Not the Sexiest
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.
- Meaningful interest rates are nearly 4% on a 1-year bill.
- High liquidity – you can get in and get out with minimal friction.
- Short-duration (< 1 year) cushions interest rate risk – if rates rise further, your T-Bill matures soon and can potentially be reinvested at higher rates.
- Credit risk is minimal – thank you, US Government.
- Opportunity cost – other bonds have higher yields, but the risks are often much higher.
- Reinvestment risk – if rates were to fall, maturing debt would likely be reinvested at a lower coupon.
If you are thinking about Roth Conversions for 2022, time is running out. Here’s what you might need to know before making this decision:
The Deadline is December 31, 2022
The deadline for all 2022 conversions is December 31. The distribution(s) must be made in 2022 and reported on your Form 1099-R.
Don’t put it off too long. Make sure to leave enough time to complete the transaction.
What’s the Trade-Off?
Converting IRA funds to your Roth IRA account will increase your taxable income for 2022. This can impact your deductions, credits, phaseouts, taxation of your social security benefits, and Medicare Part B and Part D premiums.
The trade-off is a big tax benefit down the road. If all requirements are met, distributions from your Roth IRA account will be taken income-tax free to you.
Get Professional Advice First
If you have questions about conversions, don’t guess. We are here to help.
Do You Have Excess Cash Earning Next to Nothing?
If you have extra cash sitting in your bank account, chances are it’s earning yields next to nothing.
You might be able to allow more of your money to take advantage of higher interest rates with modest risk. Come talk to us to explore if this might help you.
Tips From a Pro
Do you want to avoid the slaughterhouse during this bad market environment? Here are a few tips:
- Pay intention to what you are invested in, especially in your retirement plans. Get Active!
- Actively manage your accounts and understand that buying index funds (today) might actually harm you.
- Avoid being invested in target-date funds.
- Prioritize quality and value over fads and trends.
As you set your New Year’s resolutions, I encourage you to be proactive with your financial planning. You can control your future, but it’s up to you to make it happen.
2023 will likely be a difficult year. If you prepare, be proactive, and plan ahead you will be able to look to the future with confidence, even in times of uncertainty.
I’m here to cheer you on along the way.
Petr Burunov, CFP®
President / Wealth Strategist