Smart Investing with Brent & Chase Wilsey

November 16th, 2024 | Consumer Spending, Tariffs, Inflation, Work Income vs Retirement Income, Honeywell International Inc. (HON), Dominos Pizza, Inc. (DPZ) & Bristol-Myers Squibb Company (BMY)

Are you spending like other consumers?

Retail sales in the month of October showed an impressive gain of 2.8% compared to last year. With lower gasoline prices, gas stations were a major negative as they declined 7.1% compared to last year. If this group was excluded from the headline number, retail sales would have been up an even more impressive 3.7%. There were several areas of strength as gains were quite broad across various industries, but nonstore retailers, which was up 7.0% and food services and drinking places, which was up 4.3% continued to lead the charge. Interestingly, both furniture and home furnishing stores, which was up 1.5% and building material and garden equipment and supplies dealers, which was up 2.8% showed annual gains for the first time in many months. I wouldn’t necessarily say these categories are particularly strong, but it appears they may have finally bottomed. With that said, I do believe they could be areas of strength in 2025 considering they have both been depressed areas for a couple of years now and I believe people will look towards home improvement next year. Overall, this is further evidence that the consumer remains healthy and willing to spend in this economy. 

 

How the tariffs with China could play out over the next few months

I’m beginning to get questions from people who have concerns about the tariffs on China products such as when will they start? How much will they be and should I buy products such as appliances now before the tariffs on China begin? These are all great questions. It's important to understand the tariffs cannot be placed until after the inauguration of the Mr. Trump. It is possible on is his first day that could be one of the many things he will do when he is the official president. It is, however, possible that he may hold off on the tariffs because the purpose of tariffs is to force equal trade or free trade with China, and Mr. Trump may want to use tariffs as a negotiation tool. In 2023 the trade deficit with China was $279 billion. Mr. Trump wants China to import more goods from our economy, which was only $148 billion in 2023. This could come from such things as agricultural products and based on the amount of oil we could be pumping in 2025, we may have more oil than we can use here and maybe China will purchase some. There are also other products as well that will be on the table. It should also be noted last time Mr. Trump was in office, China’s economy was very strong, and they were not as willing to negotiate. Fast forward to today and the Chinese economy has weakened. This could mean they would be more open to talk on trade to help their economy. No one knows exactly what the new president will do or how much the tariffs will be, but if you need to buy goods that are made in China, your window of opportunity may be running out!

 

Is inflation continuing to cool?

The October Consumer Price Index (CPI) showed price gains came in line with expectations. Headline CPI increased 2.6% compared to last year and core CPI, which excludes food and energy climbed 3.3%. The headline CPI was above September’s reading of 2.4% and core CPI matched September’s reading of 3.3%. According to economists, the monthly inflation rate in October 2023 was unusually low, which made the October 2024 reading look relatively high. Hopefully, this means we will see further progress in the months ahead as core CPI has not shown much progress as of last as it has been stuck at 3.2% or 3.3% since May’s 3.4% reading. While much of this sounds problematic, there are not many areas of concern when looking at the inflation report. The major issue continues to be shelter which rose 4.9% compared to last year and accounted for over 65% of the annual increase in core CPI. I continue to believe shelter inflation will eventually resolve itself, which would then bring the major inflation measures more in line with the Fed’s desired level. Powell even said during a press conference, “Market rents, newly signed leases, are experiencing very low inflation." He also mentioned the current shelter inflation readings are due to a catch-up problem and "It's not really reflecting current inflationary pressures." I do believe with this report a December cut looks more likely, but that would not leave room for as many cuts in 2025. Based on the current data, I believe a Fed Funds Rate around 3.5% would be a fair level and that compares to a current Fed Funds Rate of 4.5-4.75%. That means if there is a cut in December, we could be looking at maybe just 3 or 4 rate cuts next year. 

 

Work Income vs Retirement Income

When planning for retirement, it’s important to understand the difference between your work income and your retirement income. If you get paid $200k/year, close to $17k/month, after taxes and savings, your net paycheck might be closer to $120k/year or $10k/month. If you go into retirement with the idea that you need to replace that entire $200k of income to continue your lifestyle, that’s just not true. In retirement you are not paying payroll taxes, which in California is a flat rate of 8.75%, you’re typically not saving much anymore, and if planned properly, you’re paying less federal and state taxes as well. In this scenario, Social Security alone might be between $5,000 and $6,000 per month for a married couple which means any retirement savings just need to cover the remaining living expense need which a nest egg of about $1 million should be able to do if invested appropriately, even after taxes are considered. We see retirees all the time where their income potential, or the maximum amount they can spend without running out of money, is much larger than they are currently living on, and they have no idea. If you’re planning for retirement, know how much you actually need so you can either retire earlier or at least have the peace of mind that you are financial independent if you’d rather keep working.  

 

Companies Discussed: Honeywell International Inc. (HON), Dominos Pizza, Inc. (DPZ) & Bristol-Myers Squibb Company (BMY)

November 9th, 2024 | Dow Jones (DOW), Election, Retirement, Taxable Social Security, First Solar, Inc. (FSLR), Five Below, Inc. (FIVE) & Sherwin-Williams Company (SHW)

Major changes to the Dow Jones you should know about!

The Dow Jones has changed again as Nvidia (NVDA) replaced Intel (INTC) and Sherwin-Williams (SHW) replaced Dow Inc. (DOW). The most recent change in the Dow Jones came on February 26th when Amazon (AMZN) replaced Walgreens (WBA). With the addition of Nvidia, much of the Mag Seven will now be present in the Dow Jones. As I mentioned Amazon was recently added, but Apple and Microsoft have been components for many years. It seems the Dow has really lost relevance as it has trailed the S&P 500 and Nasdaq in popularity and performance. I worry adding NVDA at this point in time could be buying high and at times the committee has had poorly timed decisions. Back in August 2020 the committee ended up doing a three-company swap as they eliminated Exxon, Pfizer, and Raytheon and added Amgen, Honeywell, and Salesforce. The interesting swap was Exxon (XOM) for Salesforce (CRM) considering XOM is up close to 200% not including dividends during that time period while CRM is up just around 10% during the same timeframe. Another poor decision came back in June 2018 when the committee swapped General Electric (GE) for Walgreens (WBA). Since the switch GE is up over 180% and I don’t believe that return even includes the benefit of the spinoffs GE Vernova and GE Healthcare, which would make the return even more attractive. During the same timeframe, Walgreens has had a rough time and the stock has actually fallen over 80%. While some maybe excited about the move, I wouldn’t be surprised if Intel actually outperformed Nvidia over the next 5 years. 

 

The election is over, what investors should do now!

My belief is that your plan should not have a drastic change after the Trump win, but there may be small changes to keep an eye on. The first thing I would tell people is to be careful chasing proposed winners or selling potential losers this early in the game. Ultimately, we don’t know exactly what policy changes he will be able to implement and we don’t even know at this point who will fill his cabinet. I was bullish on financials before the Trump win, but now that he will be entering office the group will likely benefit from a more relaxed regulatory environment compared to the current administration. Regional banks in particular look like they could be big beneficiaries, but be careful as many already had a big first day move after the election results. I was somewhat surprised to see big tech as a big winner as well, but it seems in today’s world everything is good for big tech. If you have been following us, you know we are skeptical of many of these big tech companies due to excessive valuations and frankly I just don’t see how a Trump presidency would be overly positive for the group. Especially considering both Trump and VP elect JD Vance have been critical of the group in the past. I would not be surprised to see continued regulatory pressure for some of these companies even after the change in the White House. Health care is also an interesting sector with Robert F. Kennedy Jr. being a large part of the Trump campaign considering his criticisms of vaccines and the food system. While this is something to keep your eye on, I don’t believe the group is completely doomed and in fact you could find some opportunities if stock prices continue to be pressured. Green energy is also in the cross hairs and many of these companies saw large declines after the results. While this may be an area of concern if the Inflation Reduction Act is repealed, I believe investors may be able to find some good opportunities if these businesses can maintain profits especially considering our need for more energy. At this point in time, I would wait for more clarity on that space as changes to tax credits could totally disrupt the current earnings picture for many of these businesses. Overall, you may be excited or disappointed with the results, but ultimately the strategy of investing in good quality companies at fair prices over the long term should not change!

 

Do you think you will be able to retire when the time comes?

At Wilsey Asset Management we continue to work very hard to encourage people to invest for retirement and also to invest wisely so they can retire at a reasonable age. What is a reasonable age? Most would say 65 but in recent surveys the average age is 62, that's a surprise to me. What is also a surprise is that in 2002 the average age of retirement was 59, and in 1991 it was 57. Could it be because people are living longer and are getting bored in retirement for 20 years or longer? I’m not sure of the reason why but it seems like we have to work a little bit harder based on a survey from New York Life that says 22% of retirees think they may never be able to retire. I have often said getting old is not that great but getting old and not having a good investment portfolio, well that can be devastating. Be sure you are taking advantage of workplace retirement plans, IRAs, or even investing in a tax advantaged brokerage account.

 

Is Your Social Security Taxable?

Social Security benefits are taxable, but they are not treated like any other source of income. Currently there are only 9 states that tax Social Security: Colorado, Connecticut, Minnesota, Montana, New Mexico, Rhode Island, Utah, Vermont, and West Virginia. The remaining states do not tax it so the majority of Americans do not need to report it on their state returns. Since this income does not take up any room in state tax brackets, it is much easier to keep taxable income lower in retirement at the state level. On the federal level, between 0% and 85% of Social Security benefits is reportable as income, so at least 15% is tax free. The lower someone’s income is in retirement, the greater chance that a larger portion of their Social Security will be tax free. The ratio of taxable to non-taxable benefits is based on “combined” income which is a Social Security Administration term that includes ½ of Social Security benefits plus all remaining income sources. If a married couple’s combined income is less than $32,000, none of their benefits are taxable. If combined income is between $32,000 and $44,000, up to 50% of benefits are taxable, and if combined income is greater than $44,000 then up to 85% of benefits are taxable. If these parameters seem low, that is because they were created in 1983 and have not been indexed for inflation. In the 80’s, $32,000 and $44,000 was a relatively high level of retirement income so most people did not have to pay taxes on it. Over the last 4 decades as income levels have naturally risen due to inflation, more and more recipients are forced to pay taxes on their benefits. It is unfortunate that Social Security is taxable at all because it used to be tax free prior to 1983. Now we are taxed in retirement when we receive it, and we are taxed on the income we earn that is used to pay into Social Security while we are working resulting in double taxation. It is possible to structure retirement income in a way that reduces the taxation on Social Security, but it is getting increasingly harder to do so.

 

Companies Discussed: First Solar, Inc. (FSLR), Five Below, Inc. (FIVE) & Sherwin-Williams Company (SHW)

November 2nd, 2024 | Presidential Elections, Job Openings, Job Report, The GDP, Retirement Plan Allocations, Chewy, Inc. (CHWY), Genuine Parts Company (CPG) & ASML Holding (ASML)

Don’t let the presidential election be your investment indicator

Presidential elections, especially this one, make people become very emotional, but don’t let that sway you away from investing. Looking back to 1950, the S&P 500 index gained 12.1% per year under Democrats and 7.1% under Republicans. So based on that tad bit of information, you would think that Democrats are better for the stock market than Republicans. If we dig deeper, we will see that Nixon had a major negative impact as he left office in August 1974. This was at the end of the 73-74 market crash when the S&P 500 was down 48%. The other Republican who had bad timing was George W. Bush, who was in office from 2001 to 2009. The S&P 500 dropped 38% in 2008 during the Great Recession and wiped out all the previous gains in the stock market while George W. Bush was in office. Looking more recently, there were investors who hated Trump as President and when he got into office, they sold their stocks missing an average annual return of 13.8% per year while he was President. The same thing happened in 2020 when Joe Biden became president, many Republicans thought the world was coming to an end and sold their stocks. The gain in the stock market under Joe Biden so far has been an 11.9% average annual return. The best advice I can give you is do not look at the President for any type of analysis on stocks, there are so many other factors at play rather than just who is in the White House. Instead, I recommend you look at the equities you are investing in and ask yourself how will they do going forward. Ultimately, businesses will find ways to succeed regardless who the President of the United States is.

 

Job openings continue to decline, is that a problem?

In the September Job Openings and Labor Turnover Survey (JOLTs), job openings declined to 7.44 million. This was below both the expectation of 8.0 million and the prior month’s reading of 7.9 million, which was revised lower by 179,000. This also marked the lowest level of job openings since January 2021. While this all sounds negative, there are still around 1.1 job openings per available worker. Also, this should be positive for inflationary concerns as the labor market is now more balanced when looking at the relationship between employers and employees. When employees have way more power like we saw over the last few years, it can have a big impact on wage inflation, which generally feeds through to overall inflation. While this isn’t an overly exciting report, I believe it still shows the labor market is in a good place. I think we could see job openings even fall a little further before it would become a concern.

 

Based on Friday’s job report, it looks like the economy is in trouble, but it’s not!

We have not seen numbers like these in the jobs report since 2020 with nonfarm payrolls only increasing by 12,000 for the month. The expectation was job creation of 100,000 jobs. Why the big miss? Right off the bat the strike of Boeing was a loss of an estimated 44,000 jobs and who can forget the two hurricanes we had in the south. It’s currently unclear how many jobs were lost during that timeframe due to those natural disasters. On the positive side, average hourly earnings did increase 0.4% for the month, which was above the estimate and the 12 month gain of 4% held steady. Revisions to August and September took out 112,000 jobs bringing the August number to only 78,000 and September’s gain declined down to 223,000 jobs. Temporary jobs are sometimes seen as underlying strength of a job market, but they have declined by 577,000 jobs since March 2022. We don’t feel this is the indicator that it used to be and we expect to see some reversal of temporary jobs for the holiday hiring season. This should start being reflected in the next month or two. The hurricanes in the south were a hit to leisure and hospitality as I’m sure many bars and restaurants were closed and the category saw drop of 4000 jobs in the month. Only two sectors in the job market saw increases which was healthcare as it added 52,000 jobs and government experienced an increase of 40,000 jobs. On the surface, the job report looks frightening, but we are out of hurricane season and heading into the holiday season. I think you’ll see a reversal in the job market in the next 2 to 3 jobs reports, which should be rather positive. Not as positive as it was during the expansion when we were recovering from Covid, but definitely better than a 12,000 job increase! There are two meetings left for the Federal Reserve and I think this job’s report would allow them to cut rates by a quarter point at the next meeting. For the last meeting of the year, we will wait for more economic data before predicting another rate.

 

Is the US economy still growing? The GDP shows it is.

While Q3 GDP, which stands for Gross Domestic Product, growth of 2.8% came in below the expectation of 3.1% and Q2’s reading of 3.0%, it is nowhere near signs of a recession. It also points to a US economy that remains in a good spot, even though it may be slowing. Remember slowing and declining are very different! The consumer continued to remain a bright spot in the economy as personal consumption expenditures added 2.46% to the headline number. This was thanks to growth of 3.7% as service spending growth was 2.6% and goods spending growth was 6.0%. Durable goods in particular were quite strong as they grew 8.1% in the quarter. Gross private investment had little impact on the headline number as it added just 0.07% to the headline number. The change in private inventories subtracted 0.17% and residential investment continued to be a problem as it fell 5.1% and subtracted 0.21% from the headline number. This was largely offset by growth in equipment spending of 11.1%. Government spending also was a large factor in the quarter as it added 0.85% to the headline number in large part due to growth of 14.9% for national defense spending. The only major category that subtracted from the headline number was trade as it had a negative impact of 0.56%. While exports were up 8.9% in the quarter, imports were up even more at 11.2%. Overall, I’d say this was a good report. I would warn people that I would not be surprised to see growth slow in the quarters ahead, but I’m still not looking for a recession in the near term.

 

Retirement Plan Allocations

The majority of working people have some type of retirement plan through their employer like a 401(k) or 403(b), but many of those people don’t pay enough attention to how those funds are invested.  Employer retirement plans are great because they automate your savings so every paycheck you have a portion that gets invested.  Over time this can build to a lot of money.  There are also no income limits you have to worry about like with IRA accounts and you get the tax benefit from making tax-deferred or Roth contributions.  However, in order to get the most out of the plan, you need to make sure you’re choosing the best investment options within that plan.  Every plan has a list of options called a fund lineup.  These may include stock funds, bonds funds, balanced funds, asset allocation funds, real estate funds, and cash funds, all of which will have different expected growth rates.  In many cases we see people choosing a random fund that they don’t understand or the default option which is usually a target date fund or stable value fund.  Target date funds generally have higher fees and an overconcentration of bonds which results in lower performance over time and a stable value fund is essentially cash which doesn’t grow.  It only takes a few minutes to update the investment options but taking the time to do it can result in thousands of extra dollars per month in retirement without actually contributing any more.  Once you choose your investments, you typically don’t need to adjust them too often, and in many cases, you can set up automatic rebalancing if you would like.  Making sure your retirement plan is set up correctly is a simple thing everyone can do which will have a huge impact on your financial future. 

 

Companies Discussed: Chewy, Inc. (CHWY), Genuine Parts Company (CPG) & ASML Holding (ASML)

October 26th, 2024 | T-Bills, Tesla, Luxury Brands, Inheritance Issues with Annuities, Capri Holdings Limited (CPRI), Expedia Group, Inc. (EXPE) & Highwood Properties, Inc. (HIW)

T-bills could be your worst investment

Right off the bat you’re thinking what how could they say such a thing? Warren Buffett has hundreds of billions of dollars in T-bills! Why do we think it’s the worst investment? First off, Warren Buffett spends all day long reading, researching, analyzing and when he sees a good value investment, he will likely sell what he needs from T-bills to buy those good long-term investments. If you are someone that needs the money in 2 to 3 years, then this belief does not apply to you as T-bills are a great place to have your short-term money. But if you’re a longer-term investor, and you want your money to grow for you, I worry that T-bills are not a great place for you. What will likely happen is that you will feel safe for a while, especially when the correction comes. You’ll be glad you have money in T-bills, but you probably won’t pull the trigger when lower equity prices arrive because you will feel comfortable with the safety and no volatility of your T-bills. Unfortunately, what will then happen down the road is you will eventually get tired of getting a lower return as interest rates drop and your T-bill is only earning you 2 to 3%. You will then likely want to move to something else and maybe do something silly like look at the past performance of equities and buy after stocks go back up after the correction. When it comes to investing, be sure to use the right tool for the right job. A T-bill is not the right tool for long term investors unless you really are a skilled investor and know how to navigate the volatility in equities.

 

One forgotten component of Tesla’s business has a huge impact on profits!

Tesla reported numbers that were ahead of analyst expectations, but I wouldn’t say I was overly impressed. Sales increased 8% compared to last year and earnings per share of 72 cents did top expectations of 58 cents. This was a growth of 9.1% for EPS when compared to Q3 2023 EPS of 66 cents. The interesting component that people forget about is revenue from automotive regulatory tax credits. To comply with emissions regulations that are set by authorities including the United States and European Union, other automakers purchase credits from Tesla. In the most recent quarter, this added $739 million worth of revenue. While this is just under 3% of total revenue, this is essentially pure profit for the company, which means it likely accounted for close to 34% of the company’s $2.17 B worth of net income. As other companies continue to ramp up their own EV and hybrid plans, a big question I would have is will they need as many credits from Tesla? Also, if there is a change in leadership after this election, will there be a reduction in regulatory requirements that could decrease the need for other automakers to purchase these credits? This could cause problems for Tesla as it would lose a very high margin component of its business. It is hard to bet against Elon considering his successes, but I have a hard time recommending this stock since it still trades at around 70x 2025 expected earnings. With that type of multiple we need to see much higher growth for sales and earnings than what we saw this quarter. Elon did mention his “best guess” for vehicle growth next year is 20% to 30%, which is one reason the stock shot higher. This seems quite ambitious and I’d be curious where that growth is expected to come from. I would say Tesla bulls continue to point towards autonomy as a potential reason to buy the stock, but at this point I would say that is a huge gamble given the elevated level of uncertainty in that space. Elon did say on the earnings call that Tesla has developed a ride-hailing app that some employees in California have been able to use this year and he expects the service to roll out for public use next year in California and Texas. The company intends to use it for a robotaxi network in the future. With that said, according to a list of permits issued on the California Public Utilities Commission’s website, Tesla isn’t currently licensed to operate a commercial, transportation network company or ride-hailing service in California. From a regulatory standpoint, I would say Tesla is behind both Waymo and Cruise. 

 

Luxury brands lose excitement as thriftiness takes over in this slowing economy

Luxury brands like Gucci, Louis Vuitton and Chanel have seen a big decline in their sales growth. These luxury brands have increased their prices so much to try and keep their products exclusive. The push back towards exclusivity came after the Covid giveaway years where many consumers became short term purchasers. Unfortunately, this has turned off their normal elite customers who saw how ridiculous it was to see prices climb from 2019 to 2024 by 50 to 100 percent. They may be rich, but they are not stupid. As things have slowed, on social media and YouTube frugality has become cool once again. This includes talking about the deals you got or even buying knockoffs, which have a new name called dupes. On many of the posts on social media and other places it is now cool to show off your dupe that you purchased and how much you saved. I remember a couple years ago I talked about how the hype for expensive purses and brand names would not continue to rise. I think we have now hit the turning point where many people who pay those higher prices for purses or shoes will not be able to sell them for anything close to what they paid for them. The reason for that is you’re no longer competing on price with the brand names but now many consumers buying secondhand will compare that price to the dupe and want to get a discount compared to the dupe price. I would not recommend investing any money into these ultra-luxury stocks, even though some are down between 40 and 50%. Many of them still trade at lofty valuations and sales growth has been cut from 20 to 30% down to 2%.

 

Inheritance Issues with Annuities

Annuities can be purchased with qualified (tax-deferred) funds or non-qualified (after-tax) funds. Because qualified money is tax-deferred all withdrawals or income taken is taxable at ordinary income rates to the owner or the beneficiaries. With non-qualified annuities, any gain in addition to the purchase amount will be taxable at ordinary income rates to the owner or beneficiaries.  There is no step-up in basis at death and they do not receive the preferential lower tax rate treatment that capital gains and dividends do. The growth is tax-deferred, but it is deferred to a higher tax rate than other investment income.  When a spouse inherits either a qualified or a non-qualified annuity, they may treat it as their own and retain all the options that their deceased spouse had.  When someone other than a spouse inherits a qualified annuity, they have the ability to rollover those funds into an inherited IRA and will be subject to the 10-year rule like any other IRA.  The most complicated situation is when you leave a non-qualified annuity to a non-spouse beneficiary.  In this case the beneficiary is typically children of the owner and they have 2 options. They can either stretch the withdrawals from the annuity over their life expectancy, which is typically better for their tax situation as they can spread out the income over many years, or they can deplete the annuity in any way they want within 5 years.  With the stretch option, they must take their first distribution within 12 months of the date of death of the owner or they will default to the 5-year option.  This requirement often causes a problem for beneficiaries because if they forget to take that first withdrawal, they are forced to realize a potentially large amount of ordinary income in a short period of time.  Owners of annuities need to understand their options so they can not only plan their own retirement income, but also have a plan for their estate.

 

Companies Discussed: Capri Holdings Limited (CPRI), Expedia Group, Inc. (EXPE) & Highwood Properties, Inc. (HIW)

October 18th, 2024 | Private Equity, Gas Prices, Money Spending, Income Tax vs Property Tax on Inherited Property, Sirius XM Holdings, Inc. (SIRI), Vistra Corp. (VST) & Etsy, Inc. (ETSY)

Where does private equity invest the money, you give them?

Private equity invests money in many different areas, but the problem that they are having is that both them and venture-capital are sitting on $2.6 trillion, which is a record high. Ultimately, they are having a hard time finding where to invest. A private equity firm generally has to earn between 12 and 14% on their investments to cover their management fee and pay investors a worthwhile return. One area they have been attracted to is HVAC, also known as heating, ventilation, and air conditioning. Other areas of interest have included plumbing and electrical companies. Over the last two years, private equity has purchased nearly 800 big HVAC, plumbing and electrical companies. It is also estimated there are plenty of smaller deals that just don’t show on the radar. I do believe somewhere down the road someone whether it’s the consumer, the employee, the business owner or the investors is going to lose. Basically, private equity is trying to streamline these smaller businesses into bigger businesses to cut costs. Many times, this changes the way they do business and it could place a larger emphasis on making more new sales rather than doing repairs, which leads to bigger profits. I do worry about the business owners who are told they can still run their business the way they want and keep a 20 to 25% stake. If things get difficult, the private equity firm with a 75% ownership will override the small business owners’ decisions.

 

Are gas prices going up or down in the future?

A big factor in the price of gas is the price of oil. If you live in a state like California, then you can add other factors like taxes and regulations. Oil has remained somewhat reasonable falling under $70 a barrel in the last few weeks, it then recently crossed $80 a barrel on concerns in the Middle East. We know there is potential for a major disruption with tensions between Israel and Iran showing signs of escalation. The war in Ukraine continues to linger on, but so far it has not deterred Russia from selling their oil to countries like China and India. We also have a change in our president quickly approaching and everyone has to ask themselves, who would be more likely to tame the violence in the Middle East? If the next president cannot reduce or stop the fighting, we could see Israel start sending missiles towards Iran’s energy infrastructure. This could then lead Iran to try and restrict or block oil tankers flowing through the Strait of Hormuz. These actions would likely cause oil to skyrocket to over $100 per barrel, which could mean a 20 to 25% increase in the price of gas at the pump. What has kept oil and gasoline prices low so far has been slowing demand from a weak economy in China and talks of OPEC exporting more oil come December. It’s also important to know that there is less oil in storage than the historical average, which could mean there is pent up demand to refill that storage. If you’re an investor, I think it makes sense to have at least 5% of your portfolio in oil and natural gas companies because I believe the upside in the price of oil unfortunately is much greater than the downside.

 

Are you still spending money in this economy?

Retail sales have continued to prove resilient as in the month of September we saw growth of 1.7% when compared to last year. With the decline in the price of gasoline, gas stations saw a decline of 10.7% compared to last year and if this component was excluded from the headline number, retail sales would have grown at a stronger rate of 2.8% in the month. Areas of weakness included furniture and home furnishing stores (-2.3%) and electronics and appliance stores (-4.6%). One area that showed positive growth for the first time in a while was building material & garden equipment & supplies dealers. It was a very small annual gain of 0.5%, but could this finally be the turning point for a group that has struggled tremendously over the last couple years? Areas of strength in the report included nonstore retailers (+7.1%), health and personal care stores (+4.6%), and food services and drinking places (+3.7%). While the growth in retail sales isn’t setting the world on fire, I believe this report provides further evidence that this economy is in alright shape.  

 

Income Tax vs Property Tax on Inherited Property

There are many factors to consider when inheriting real estate, especially in California, and the tax impact is one of the largest.  When receiving an inheritance of property there is an income tax consideration and a property tax consideration.  When capital assets, such as real estate, are sold for more than they were purchased for, the increase in value is considered a capital gain which is a type of income.  When property is inherited, it generally receives a step-up in basis which means the original purchase price is no longer relevant and the new income tax basis is the value of the property as of the date of death of the owner.  This means a parent who purchased a property for $200k and passes away when it is worth $1 million can leave it to their children who will not be responsible for the tax on the $800k gain. If they do sell, they will only need to report income on the appreciation after the date of death, or the amount over $1 million.  This is obviously a benefit and applies to other assets as well such as stocks and bonds.  However due to Prop 19, there may be a counteracting property tax implication when inheriting real estate.  In California the property tax assessed value can only increase by a maximum of 2% per year, even if the fair market value of the property increases much more than that.  Because of this people who have owned properties for many years are paying relatively little in property taxes compared to the actual value of their real estate.  However, when the property is inherited, the property tax assessed value increases to match its fair market value, resulting in a much higher property tax bill every year going forward.  As a result, vacation homes and rental properties that were great investments become unaffordable when the heirs receive them.  This often causes the sale of the property, which fortunately can be done income tax free due to the step-up received at death. There is an exception to this property tax increase where if children inherit the primary residence of their parents and begin treating that property as their own primary residence, they may add up to $1 million to the property tax assessed value before being required to pay additional property taxes.  Understanding these tax issues can help you determine when property should be held or sold before or after an inheritance. 

 

Companies Discussed: Sirius XM Holdings, Inc. (SIRI), Vistra Corp. (VST) & Etsy, Inc. (ETSY)

October 12th, 2024 | Inflation, PPI (Producer Price Index), Gold (GLD), US Chicken Consumers, Retirement Goals, Roblox Corporation (RBLX), Tesla Inc. (TSLA) & Pinterest, Inc. (PINS)

Inflation comes in hotter than expected, is that a problem?

The Consumer Price Index (CPI) showed September headline inflation was up 2.4% compared to last year, which was a little higher than the estimate of 2.3%. Core CPI, which excludes food and energy was up 3.3% compared to last year and it also came in a little higher than the expectation of 3.2%. While the numbers were a little hotter than expected, headline CPI was down from last month’s reading of 2.5% and it registered the smallest increase since February 2021. It’s come a long way from the high that was reached in June 2022 when headline inflation grew 9%. The major discrepancy between the headline and core number was energy. The energy index was down 6.8% compared to last year and gasoline prices had a major impact as they were down 15.3% over the same time frame. Shelter costs continued to have an outsized impact on the report as the index was up 4.9% over last year and accounted for over 65% of the 12-month increase in core CPI. The decline in inflation has continued to moderate, but overall, it has continued to trend in the right direction. While this report was somewhat disappointing, I don’t think there is anything of major concern in this report. With the Fed’s next meeting coming in November, it will be interesting to see how they interpret all the data as there are several factors that will have hopefully just a short-term impact on inflation and the labor market. These factors include both Hurricane Helene and Hurricane Milton as well as a Boeing strike that has had roughly 33,000 union workers on strike since September 13^th. Given all this my estimate at this point in time would be that the Fed will do a quarter point cut at that November meeting.

 

What is PPI and how it can affect you as a consumer

PPI stands for Producer price index. It’s important to understand these monthly numbers because it will eventually have an effect on consumers. If the cost of producing something increases, that cost will generally be passed to the retail level where consumers purchase.

While September headline PPI of 1.8% was higher than the expectation of a 1.6% increase, it is still a low level that shows no major concern on the inflation front. When excluding food and energy, PPI increased 2.8%. This was higher than the estimate of 2.7% and last month’s reading of 2.6%. It was somewhat disappointing to see a small increase over last month’s reading, but overall, it has continued to head in the right direction and at 2.8% I believe inflation at that rate is still manageable. It is worth keeping an eye on this data as the months progress, but it seems to have less impact on the markets now that inflation has become more manageable.

 

Gold is up about 28% year to date, here are a few important points to help you decide to buy, sell, or hold.

I hear the thoughts out there that as interest rates decline, gold should rise and so far, that has held true. But if you go back in history, in the early 80s as interest rates fell so did gold. Let’s say that correlation does hold true though, I’m not overly optimistic that we will see a large decline in the 10-year treasury as historically it yields about one and a half percent more than inflation. I believe inflation should be around 2-3% going forward. My other major concern for why I don’t see long term rates falling much further is the United States continues to struggle with a huge debt load. Looking at gold purchasing, central banks from around the world including countries like China, India, and Poland bought more than 1,000 metric tons of gold in both 2022 and 2023, but in 2024 we have seen those purchases slow down. The countries have become a little bit more concerned given the large gain this year. Some of these countries could even consider locking in some profits and sell some of the gold they own. If you still insist on buying gold, you can buy the gold bars at Costco, which has been a huge hit for them, but if you notice they don’t have a program to buy back gold. So when you want to sell those one ounce bars from Costco, you will have to go to a dealer who will charge a markup somewhere between five and 10%, which can eat into your gain more than you think. If you paid $2000 for gold and sold at $2700 you have a paper profit of 35%, but if you pay a 10% commission on that $2700, your gain drops to $430 which gives you an after commission gain of only 21.5%. Another option if you are looking to benefit from the price of gold is mutual funds and gold mining stocks, but because of the trading the returns don’t track the performance of gold very well. If you really insist on adding gold to your portfolio, then I would suggest the best way to do it is an ETF like GLD, which has low fees and tracks closely the price of gold. Full disclosure, we do not hold any gold in our portfolio now nor do we plan on buying it in the near future!

 

US consumers love their chicken!

In 2023 the average American consumed more than 100 pounds of chicken wings, legs, breasts and thighs, which was an all-time high. American farmers are cranking out about 10 million chickens per year. This includes various forms from organic, free range, antibiotic free, and the list goes on. Compared to beef and pork, chicken is a better value. Unfortunately, the price of chicken has increased dramatically over the last five years. Back in 2019, the average chicken was going for $3.11 per pound and today that average cost comes in at $4.08 per pound, which is $.97 more or a 31.1% increase. I personally consume a fair amount of chicken as I think it tastes good and it’s also easy on your digestive system. I know the cost of chicken is up, but are you consuming the same amount of chicken you were five years ago?

 

Prioritize the Right Retirement Goals

The most common goal when planning for retirement is to not run out of money. This is obviously important, but it should not be the only goal and in many cases, it should not even be the priority.  If you get to the point where your assets and income greatly exceed what is needed for your lifestyle, the chances of outliving your money decline and the priority should shift to income tax minimization.   For example, if you have a $2 million portfolio but only need $3,000 per month to supplement your social security or pension income, you probably won’t ever run out of money.  However, if you don’t implement the right tax strategies, you will end up paying way more than you need to and the longer you wait the worse it gets.  If your portfolio is $5 million to $10 million or more, you likely aren’t too concerned with running out of money and you hopefully are implementing income tax reduction strategies.  However, at this point you should also be thinking about estate taxes.  This has been largely disregarded because the currently exemption amount for a married couple is so large at about $27 million.  In 2026 though this number is expected to be cut in half to around $14 million, and the tax rate on estates that exceed that will potentially increase from 40% to 45%. An estate worth $14 million is still quite large, but compounding interest is a powerful thing.  A portfolio of $5 million can easily exceed $20 million after 20 years of growth, and waiting to address this until your estate reaches the exemption limit makes tax planning more difficult and more expensive because the value of assets will only grow faster over time.  It is too common for people to fixate on not running out of money and end up neglecting their income and estate tax planning which ultimately just results in more taxes.

 

Companies Discussed: Roblox Corporation (RBLX), Tesla Inc. (TSLA) & Pinterest, Inc. (PINS)

October 5th, 2024 | Jobs data, Employment report, ILA Dockworkers strike, Money Market Funds, Spousal Social Security, Costco Wholesale Corp (COST), Humana Inc. (HUM) & LyondellBasell Industries (LYB)

More jobs data points to a healthy economy
The Job Openings and Labor Turnover Survey (JOLTs) showed a surprise increase in the month of August. Openings totaled 8.04 million, which topped the estimate of 7.64 million and July’s reading of 7.71 million. While this is still well off the highs from just a couple of years ago, there are still 1.1 available jobs for every person looking for one. On the inflation front, I believe it was positive to see the quits rate decline to 1.9%, its lowest level since June 2020. This indicates that the labor market has softened as employees are seeing less opportunity to quit their job in favor of another one. This should help put less pressure on wage inflation. The Fed will have to continue to walk the fine line of keeping the economy moving in a positive direction without stoking a rise in inflation. It’s a tough task, but the labor market has continued to hold up much stronger than many believed was possible. 

 

Employment report surprises to the upside     
I was surprised to see the continued strength in the labor market as the growth of headline nonfarm payrolls of 254k in the month of September easily topped the estimate of 150k. Strength came from leisure and hospitality, which saw payrolls grow 78k thanks to a nice spike of 69k jobs from food services and drinking places. Other positive sectors included health care and social assistance (+71.7k), government (+31k), and construction (+25k). Only two sectors saw declines in the month with manufacturing losing 7k jobs and transportation and warehousing down 8.6k jobs. Both July and August saw upward revisions to their reports for a combined total increase of 72k. Wage inflation was also stronger in the month as average hourly earnings grew 4% compared to last year. This is up from last month’s reading of 3.8%, but still remains substantially below last year’s high of 5.92%. Precovid, wage growth was in the low to mid 3% range. Overall, this report didn’t have many problems. The only concern is, did the Fed move to soon and could inflation still be the larger concern rather than a weakening labor market? This report did increase expectations for a November rate cut to be 0.25% rather than 0.5%. I would have been shocked if the Fed would have opted for another 0.5% cut even if the jobs report wasn’t this strong. 

 

ILA Dockworkers strike
Good news for those that were concerned about the International Longshoremen’s Association’s (ILA) strike as the union and the United States Maritime Alliance reached a tentative agreement on wages and agreed to extend the Master Contract until January 15th, 2025. Wages will increase 61.5% over six years under the tentative deal, but the major point of conflict that still needs to be negotiated is port automation. With the increase in wages, it will be interesting to see how much the Maritime Alliance is willing to budge on automation as they will likely need to look for ways to improve efficiency to offset the higher wages. Efficiency is already a concern for US ports as a study from just a couple of years ago ranked the LA and Long Beach ports as the least efficient trade hubs for handling containers in the world. Other US ports including Savannah, Georgia, New York, and New Jersey also ranked in the bottom half of the list. Of the 370-member Container Port Performance Index, we did not have a single port in the top 10. While this resolution is positive, the problems could be delayed until early next year if the two sides still cannot come to an agreement. During my research on this strike, I learned some surprising things about the union leader, Harold Daggett. You may be shocked to learn that his combined income as president of two unions is around $900,000 per year with $728,000 coming from the ILA. He currently drives a Bentley, which is a high-end luxury vehicle with a price of $210,000 for a new one. He also recently sold his 76-foot yacht and based on the US boat group market index, the average price of a yacht in that range is $1.5 million and costs around 10 to 15% of the value to operate yearly. I was also surprised to see this is a “family business” as his son is employed by the same two unions as his dad and was paid a total of more than $700,000 last year. As for the workers, on the East Coast the union workers have an average pay around $81,000 per year. However, the waterfront commission of New York estimates 1/3 of the longshoreman made $200,000 or more last year with overtime. 

 

Investors are still adding money to money market funds
Even with the recent rate cut by the Federal Reserve, investors still put nearly $130 billion into money market funds. This brought total assets in money markets to $6.8 trillion. I don’t believe this money will stay there very long as probably within 3 to 6 months investors will start seeing the interest rates decline and once, they fall below 4%, we could see a large drop in the assets held in money market funds. The big question for investors is where to go. If you need liquidity, you’re probably best off staying in the money market funds, but if you won’t need the money for the next 3 to 5 years, you should be looking at building a strong investment portfolio using patience and a lot of research to make sure you have the right investments. 

 

A Lesser-Known Spousal Social Security Strategy
After 2015 many of the spousal strategies such as the file and suspend or restricted application options are no longer possible. This is because a “deemed filing” rule applies which means when someone files for Social Security benefits, they are deemed to be filing for all benefits they are eligible for such as spousal and their own benefits.  When they apply, they will receive whichever benefit is larger, but not both.  However, there is still a way to switch between benefits. In order to receive a spousal benefit, the spouse you are collecting from must also be collecting. If they are not, you would only be eligible for your own benefit until they begin collecting.  Consider a wife who is no longer working and whose full retirement age 67 amount is $1,000 and who has a working husband with a full retirement age amount of $3,500.  Because of the husband’s larger benefit, the wife is also eligible for a spousal benefit of half that amount, $1,750, if she collects it at her full retirement age.  In this situation the wife may collect from her own record as early as age 62.  Since she would be collecting 5 years early, her own benefit would be reduced from $1,000 to $700.  Later on though, when her husband retires and starts his own social security, she could begin her spousal benefit at age 67 and boost her benefit by $750 up from $700 to $1,450. This $750 boost is because her spousal benefit of $1,750 is $750 larger than her own full retirement age amount of $1,000, even though she began collecting at 62.  If she had waited to apply for anything until age 67, she would receive the full spousal benefit of $1,750, but she would have waited 5 years of collecting nothing just for an extra $300.  From a Net Present Value perspective, it is better for the wife to collect her own benefit at 62 and later receive the spousal boost rather than wait completely until 67.  Also, there are many spouses who collect early without knowing they are also eligible for a larger spousal benefit when their spouse retires.  If they do not alert the Social Security Administration, they may not ever receive their increased benefit.

 

Companies Discussed: Costco Wholesale Corporation (COST), Humana Inc. (HUM) & LyondellBasell Industries (LYB)

September 28th, 2024 | Housing Problem, iPhone 16, ETF’s, Tax Code, Third Type of Retirement Account, Uber Technologies (UBER), Lennar Corporation (LEN) & Alibaba Group Holding Limited (BABA)

We do have a housing problem in this country, but it may not be the one you’re thinking.

The price of homes has continued to rise and it has left some people out of the housing market, but that may not be a bad thing. I say that because people are doing anything they can to buy a home at these high prices. This includes risky endeavors like cashing in their retirement savings or borrowing from friends and family. The Atlanta Fed’s affordability index was recently at 68.5, which would mark its lowest levels since 2006. I worry people are getting in over their heads as ownership costs, which include mortgage, taxes, and insurance are now occupying nearly 44% of median household income. Generally the 30% level is considered a threshold for affordability and that was last seen in 2021. I worry when the economy slows down, you could see people selling their houses because they can’t afford them. I think it’s rather silly that some campaign promises have talked about giving $25,000 for down payments or expanded tax credits for developers to build affordable rental housing. These sound good as soundbites, but I think they’re terrible ideas because all they will do is pushup demand and that will continue to put more pressure on prices. People don’t realize that builders say roughly 25% of the cost of new homes is from regulatory costs like building codes and zoning issues. If we could get the local government to back off, you could see a nice reduction in prices. The problem is we have the federal government trying to give you money to buy a higher priced home and local governments are raking in the dough collecting fees on those higher priced homes. Throughout history, it has never been great to invest or buy into any type of asset when there is a buying frenzy going on. Look at the history books if you don’t believe me and then think ahead what will happen in the next 5 to 10 years. I know my opinion goes against many experts, but in our over 40 years in asset management, we have seen how things can change unexpectedly.

 

Is the new iPhone 16 going to move the stock price up?

Last weekend an article in Barron’s written by Alex Eule tried to convince people that Apple stock will increase based on looking back to the original iPhone and every iPhone release after that. Based on the research, Apple stock has returned an average of 11.7% six months after iPhone releases. But before you run out and buy the stock, one thing I noticed was there was no discussion around price/earnings ratios during those launces. I believe it is very important to not over pay for any company and I am curious what the PE ratios were during those last 24 iPhone launches. Holding Apple several years ago I know the multiple was not where it is now in many of those cases. Don’t get me wrong, I think Apple is a great company and has great products, but I worry with the stock trading at 31 times next year ‘s earnings it is more than fully valued. I also believe some of that data was skewed considering the first iPhone launch led to 63.7% return six months after the release and there are several instances where the stock did nothing or actually fell like the iPhone 12 (-3.4%), the iPhone 13 (-1.3%), or the iPhone 15 (-1.0%). I was surprised to see that analysts are more negative than I expected on the stock as currently nearly 1/3 of them have either a hold or a sell rating. Mr. Eule does correctly point out that if Apple beats expectations, the price earnings ratio will come down. However, that assumption would also mean that the stock price did not climb to offset the earnings beat. We have avoided investing in Apple for quite some time now, but I will still not break my discipline and I will not overpay for any company because history has proven eventually everything comes back to the norm. 

 

ETFs have proven not to be as effective as mutual funds

When Jack Bogle, the founder of Vanguard, was CEO back in the 90s, he refused to add indexed ETFs (exchange traded funds) to their lineup. His concern was it was too easy for people to jump in out of the products and not be long-term investors. There are now long-term studies proving that he was right. A report from Morningstar shows there is a 0.9% per year gap over the study’s 10-year period favoring investors who used indexed mutual funds over investors who used indexed ETFs. While it might not sound like a lot, the compounding takes hold in the long-term and I believe it further illustrates why people should not trade. Unfortunately, even financial advisors who control about 2/3 of the ETF assets appear to be just as jumpy and emotional as their clients. Maybe they’re just trying to prove their worth due to the management fees that they charge on top of the ETF fees.

 

Is our tax code too complicated?

I know many people hate paying taxes, but have you ever thought about how much time you spend compiling all those documents? According to the Tax Foundation, it is estimated that the time and money individuals and businesses are spending on complying with the federal tax code this year could reach 7.9 billion hours and $133 billion in out-of-pocket expenses—or $546 billion when also accounting for lost productivity. I believe a major problem is that we keep adding more and more complications to the tax code and between 1994 and 2021 it grew in length by 40% to about four million words and has expanded steadily since. Regulations keep climbing and according to the National Taxpayers Union Foundation, from 2000 to 2022 the Department of Treasury’s annual volume of regulations grew 35% to 17,631 pages from 13,070. With all the complications, it’s no wonder most people don’t understand how taxes work and what they actually pay in taxes!

 

The Third Type of Retirement Account

When it comes to retirement accounts, most people are familiar with 401(k)s, Rollover IRAs, and Roth IRAs.  These accounts have tax benefits when contributing and withdrawing money and allow either tax-deferred or tax-free growth.  However, there are also restrictions such as annual contribution limits and age requirements to make qualified withdrawals.  In addition to these pre-tax or Roth accounts, it can also be helpful to supplement retirement income with a third type of retirement account, which isn’t a retirement account at all – the taxable brokerage account. There are no limits when making contributions or withdrawals and technically withdrawals from this account are not taxable.  This account produces income in the form of capital gains, dividends, and interest which must be reported every year whether withdrawals are taken or not, which is why the withdrawals are not a taxable event.  However capital gains and dividends are taxed at a lower rate than other types of income and in retirement it is more common to be in lower tax brackets which means the tax rate on those gains and dividends can be as low as 0%.   Retirees may have gross income of $125k or higher in some cases while still falling in that 0% tax rate.  It is great and typically preferred to fund retirement accounts but if those are being maxed out, it can make sense to put addition savings into a taxable account.  These types of accounts aren’t utilized as often as they should and they are more commonly used when receiving a large sum of money such as an inheritance or proceeds from selling a property; but combining them with other “retirement” accounts adds flexibility and tax diversification when structuring withdrawals in retirement.

 

Companies Discussed: Uber Technologies (UBER), Lennar Corporation (LEN) & Alibaba Group Holding Limited (BABA)

September 20th, 2024 | Retail Sales, Fed’s Rate Cut, S&P 500, Dividends, Rate Reductions for Refinancing, Nike Inc. (NKE), Snap Inc. (SNAP) & Lululemon Athletica Inc (LULU)

Retail sales shows the consumer is still spending

August retail sales were expected to decline 0.2% in the month, but the consumer was more resilient than anticipated as they actually grew 0.1% compared to the month of July. Compared to last August, retail sales were up 2.1%. Gas stations were the biggest negative in the report as lower prices for oil and gasoline lead to a 6.8% decline compared to the prior year. If this volatile category was excluded from the headline number, retail sales would have climbed by a more impressive 2.9%. Areas of strength included nonstore retailers (+7.8%), healthcare & personal care stores (+3.5%), food services & drinking places (+2.7%), and electronics & appliance stores (+1.9%). Two areas that continued to bring down retail sales were furniture & home furnishing stores (-0.7%) and building material & garden equipment & supplies dealers (-0.1%). While this report doesn’t point to a booming consumer, it definitely doesn’t show an economy that is in recession. 

 

What should investors do after the Fed’s rate cut?

What should investors expect going forward when interest rates decline? Going back 50 years, when the Fed begins its interest rate cuts, 16 out of 23 times 6 months after the first cut the stock market was higher. Could this be like one of those seven times it is not higher six months from now? Investors have to realize that valuations for the market are very high and this could lead investors holding those high valuation equities to sell the news. I do believe if you were a strong investor and have watched what you have paid for the earnings and cash flow of what you have invested in, you should be OK. But if you do hold in your portfolio equities trading at 25 to 35 times forward earnings, this could be a buy the rumor, sell the news situation. At our firm, Wilsey Asset Management, I know our portfolio has an average forward P/E ratio of around 12. I believe this is a very comfortable place to be in this crazy time. I would advise you to analyze your portfolio to be sure it is not overvalued.

 

Why you should be careful investing in the S&P 500!

People continue to shift towards index investing and have a desire to invest in the S&P 500 index fund because they believe it is a good diversified investment. I continue to worry that people do not realize how risky this index has become with the overconcentration in just a few expensive stocks. The S&P 500 currently has a forward P/E of around 22-23x, which is well above the historical average of around 16-17x. The reason for this elevated figure is the outsized weight of the expensive growth stocks. If you look at the 10 largest stocks, which are Apple, Microsoft, Nvidia, Amazon, Alphabet (Google), Meta (Facebook), Berkshire Hathaway, Eli Lilly, Broadcom, and Tesla they now occupy over 35% of the entire index and their average forward P/E is lofty at nearly 40x. People believe they are getting a diversified portfolio, but Apple (6.86%), Microsoft (6.72%), and Nvidia (6.24%) all have larger weights than the entire sectors of real estate (2%), materials (2%), utilities (2%), energy (4%), and consumer staples (6%). Communication services has a weighting of 9%, but Meta and Alphabet make up a combined 43% of the Communication Services SPDR ETF. Consumer discretionary has a weighting of 10%, but Amazon and Tesla make up over 38% of the Consumer Discretionary SPDR ETF. While the performance of the S&P 500 has been great over the last decade, if the performance of these mega cap stocks turn so will the index. With these expensive valuations, I just don’t see exciting returns over the next decade. I definitely don’t believe they will even be close to what we saw over the last 10 years. Just for reference, the remaining sectors of the S&P 500 are industrials (8%), healthcare (12%), financials (13%), and technology (31%). 

 

How will dividends impact the stock market’s return?

People may not realize that stock dividends historically have accounted for around 40% of the total return in the stock market. However, because of the unbalanced market over the last 10 years, dividends have accounted for just 16% of the total return. I believe over the next decade as markets adjust to more normalcy, dividends should once again play a larger role in the total return and I wouldn’t be surprised to see it return to a similar rate of around 40%. Places you can look for dividends would include real estate investment trusts, utilities, energy, along with financial stocks and healthcare. But as always, when investing, be sure to make sure the investment is not overpriced and is fundamentally strong based on the financial statements. 

 

How Much of a Rate Reduction is Needed to Refinance?

With interest rates coming down, more people are starting to wonder if refinancing makes sense, but how much of an interest rate reduction do you need to be worth it? Half a percent, one percent, more? A lot of people get hung up on the interest rate alone, but you must also factor in the costs associated with getting the loan. When you get a new mortgage there are three types of costs- fees paid to originate the loan like points and underwriting fees, prepaid expenses like interest and homeowner’s insurance, and other 3rd party fees like title and recording fees. When deciding on a refinance, the prepaid fees are irrelevant because they will still be paid whether you refinance or not. That leaves the origination and 3rd party fees as the actual cost it takes to get a new loan. It is important to differentiate the two because mortgage companies often advertise no point or no cost refinances, but they are generally referring to the origination fees. As the borrower you still have to pay the other miscellaneous fees, you just aren’t paying them to the lender. Most people are familiar with points which are upfront fees in exchange for a lower interest rate. Over time the interest savings makes up for the points but only if you keep the same loan. You would not want to pay points if you expect to refinance again or sell in the foreseeable future. Since most people agree that interest rates are at least slightly coming down, most borrowers should not be paying points as there will likely be an opportunity to refinance at a lower rate. Instead of paying points, you can do the opposite and accept a higher interest rate in exchange for “lender credits”. These credits can then be used to pay the fees which results in a true “no-cost” refinance. Consider a situation where you have a mortgage at 7% and the ability to refinance into a 6% loan but at a cost of $15,000 in fees. Instead, it would likely make sense to refinance into a higher 6.5% loan using credits to cover the cost and then refinance again in 6 months assuming rates will be lower. In other words, you wouldn’t want to spend an extra $15,000 to save $1,500 in interest over the next 6 months. With this logic, even the smallest rate reduction at no cost would still make sense.

 

Companies Discussed:  Nike Inc. (NKE), Snap Inc. (SNAP) & Lululemon Athletica Inc (LULU)

September 14th, 2024 | Derivatives, Interest Rate Cuts, Health Insurance Premiums, Home Owning Tax Benefits, Topgolf Callaway Brands (MODG), United States Steel(X), McDonald's (MCD)

Another lesson on why investors should stay away from derivatives 

The well-known mutual fund company, Franklin Templeton, has a division known as Western Asset Management, WAM. Please do not confuse that with our investment firm, Wilsey Asset Management, also referred to as WAM. Western Asset Management received a Wells Notice from the Securities and Exchange Commission (SEC), which informed them that the agency was planning on enforcing some action against them. From the spring of 2021 through the autumn of 2022, the manager Ken Leech, who by the way has now taken a leave of absence, did 17,000 treasury derivative trades. The fund performance was horrendous and the three funds he managed lost as much as half of their assets as investors sold their shares. There is nothing proven yet, but if you hold these funds or other Franklin funds, I would definitely be selling my shares and looking elsewhere. I have known the Franklin funds for nearly 30 years and it is disappointing to see this type of news for that company. Full disclosure, we stopped using their funds well over 20 years ago and have zero dollars invested with them at this time 

 

Boring inflation report likely secures a 0.25% interest rate cut next week

August headline CPI rose 2.5% compared to last year, which was below the estimate of 2.6% and marked the lowest reading since February 2021. The headline number benefitted from energy prices that were 4.0% lower than last year, largely thanks to a 10.3% decline in gasoline prices. The other normally volatile category, food, was also quite subdued as it showed an increase of just 2.1% compared to last August. Food at home showed a small increase of just 0.9%, while food away from home was up 4.0%. Core CPI, which excludes food and energy was up 3.2% compared to last year, which matched the reading in July. The lack of progress on core CPI is the main reason I believe a 0.25% cut will be preferred over a 0.50% cut at next week’s Federal Reserve meeting. Shelter really remains the key hurdle for core CPI as it increased 5.2% compared to last year and accounted for about 70% of the increase in core CPI. The shelter number is still puzzling to me considering the BLS New Tenant Rent Index actually fell 1% in the second quarter. At some point these shelter costs in the CPI will come down, I’m just shocked at how long that process is taking. Auto insurance continues to steal the show in terms of large gains as the category was up 16.5% compared to last year. A positive for the category as we move forward is both used cars & trucks (-10.4%) and new vehicles (-1.2%) saw declines compared to last year. While high, motor vehicle and maintenance (+5.1%) has cooled from earlier levels. This should all lead to more subdued auto insurance inflation next year. 

 

Diet drugs could cause health insurance premiums to skyrocket

Weight loss drugs have become very popular as an easy way to lose weight, but who is going to pay for this more expensive option? Some of the drugs cost about $13,000 a year and there are now some discount versions that were recently announced that will still be around $6,000 to $7,000 a year if you’re willing to get a separate needle and vile to inject yourself, rather than using the autoinjector version. It is estimated that in 2024, Zepbound and Mounjaro combined sales will reach $18.3 billion. In 2025, it is estimated that the sales for these two drugs will hit $28.7 billion. What people do not realize is the strain this is beginning to put on the US healthcare system. Insurance companies make money by collecting insurance premiums from many people and calculating out what they will likely have to pay out in claims. It is obvious that if claims will be rising because of the high cost of these diet drugs paired with many people using them, the only solution is to increase insurance premiums. Some insurance plans and even Medicare won’t pay for the weight loss drugs to help with weight loss but ways around it include saying they reduce the risk of heart failure, sleep apnea, and stroke. I believe to help correct the situation, these drugs need more competition to bring more supply to the market and reduce prices. I know of a couple of other companies like Pfizer and Viking Therapeutics that are very close to releasing their own weight loss drugs. Hopefully these additions will dramatically reduce the cost of these drugs so that people can pay for them out of pocket and leave the insurance companies to cover the big expenses our healthcare system incurs. 

 

Tax benefit of owning a house

Everyone likes to talk about the tax benefits of owning a home, but it’s important to understand what the true benefit is before deciding to purchase. When buying a home, the property taxes and mortgage interest are itemized deductions that can reduce taxable income for federal and state taxes. However, you need enough itemized deductions to exceed the standard deduction in order to receive any tax benefit. For married couples, the federal standard deduction is $29,200 and the California standard deduction is about $11,000. If you own a home but your total federal itemized deductions after paying your mortgage and property taxes are only $25,000, you won’t receive any federal tax benefit even though those expenses are technically deductible because you will still end up claiming the higher standard deduction. This situation is more common for people who have owned their home for a while because their property taxes are generally lower due to Prop 13 and they likely would have refinanced their mortgage when rates were lower which reduces the amount of interest they can claim. For people buying new homes, there are typically more expenses which can result in tax savings. On the federal side, the most common itemized deductions are mortgage interest on loans up to $750,000, state income and property taxes capped at $10,000, and charitable giving. In California mortgage interest is deductible on loans up to $1,000,000, property taxes but not state income taxes are deductible, and charitable gifts are deductible. If you are buying a $500k home, your tax savings will likely be between $4,000 and $6,000 per year; with a $1 million home, it’s likely between $10,000 and $12,000 per year; and with a $2 million home, it’s likely between $15,000 and $20,000 per year. The actual tax savings will vary based on the value of the home, the loan balance, the interest rate, and your tax bracket. It’s always great to reduce taxes, but this means you are paying anywhere from $40,000 to upwards of $100,000 in interest and taxes to get those levels of tax savings. Also keep in mind that taxes are likely to change in 2026 which will largely increase the tax benefit of owning a home. As with any financial decision, it is important to understand the whole picture when buying a home, not just the potential tax benefits.

 

Companies Discussed:  Topgolf Callaway Brands (MODG), United States Steel(X), McDonald's (MCD)

September 7, 2024 | The labor market, Economy, Price Gouging, Roth Conversions, DraftKings Inc. (DKNG), Dollar General Corporation (DG) & Dell Technologies (DELL)

The labor market continues to soften

The Job Openings and Labor Turnover Survey (JOLTs) showed job openings continued to fall across the country in the month of July. It was reported that available positions fell to 7.67 million in the month, which 237,000 lower than June’s downwardly revised number and well below the estimate of 8.1 million. While this marked the lowest level since January 2021, there were still close to 1.1 job openings per available worker. I do believe we still have some room left for normalization before these declines in job openings becomes problematic. This news also caused the relationship between the 10- and 2-year Treasury yield to uninvert for the first time since June 2022. Generally long-term rates are higher than short term rates and I believe we will see the yield curve continue to steepen as the Fed cuts rates. While the curve usually reverts before a recession hits, I still believe we aren’t heading towards a problematic recession in the coming months.

The labor market is definitely slowing

Nonfarm payrolls increased by 142,000 in the month of August, which was up from 89,000 in July, but below the estimate of 161,000. Both June and July also saw downward revisions, which totaled a substantial 86,000. Leisure and hospitality (+46K), healthcare and social assistance (+44.1K), construction (+34K), and government (+24K) led the way for job gains in the month. Manufacturing (-24K), retail trade (-11.1K), information (-7K), and utilities (-200) all subtracted jobs from the headline number. I was also surprised to see professional and business services only create 8K jobs in the month and I believe that is a good indicator that the economy is definitely in a slowdown. While the numbers don’t look great, I still believe there is no cause for major concern at this point. With an unemployment rate of 4.2% and the major gains we saw coming out of Covid, it was unlikely we’d see that type of labor market continue. I still believe it’s possible we see a soft landing, but in that scenario, you wouldn’t see major payroll gains every month and the prints would likely be more muted and even softer than the readings we have seen the last few months. My expectation is for the Fed to cut rates by 0.25% at the September meeting followed by cuts of 0.25% at both the November and December meetings.

The economy is getting back to normal

It may feel like the economy is weak, but I believe that is because we are comparing it to an excessive economy that had too much money floating around and people spending it pretty much on anything they wanted while not caring about how much they paid. Now that extra cash is gone and we’re back to normal. That might feel uncomfortable for some people as they now can’t spend so easily on things like luxury items. Proof of this can be seen in the used luxury watch market which was very hot, but has now seen prices fall over the last 9 quarters because the demand is gone. I don’t care if you’re buying stocks, homes, or luxury items, if you overpay during the hype, you’ll probably end up losing money down the road. I believe it’s always best to buy things on sale, even if that means being patient for a few years.

There’s a lot of talk about company’s price gouging, but the numbers tell a different story!

There is no doubt that with inflation, prices for many items have increased over the last five years. But are businesses taking advantage of these higher prices to increase their profit margins? Looking at just the companies in the S&P 500, the average price markup between the selling price and the cost is 54%. That compares to 51% five years ago. According to research from financial company Bloomberg, they say the grocery business markup is actually down from five years ago and when looking at the average profit margins for grocery stores, it is now 0.3% lower than five years ago. You may not like the information because we want to blame somebody for paying higher prices, but based on these numbers companies are not price gouging. We do believe every business has a right to make a decent profit for being in business, but the free market and competition should eliminate price gauging and keep the market balanced.

How the Time Value of Money Impacts Roth Conversions

When you do a Roth conversion, the amount you convert into a Roth account is taxable when you do it. First, this means you are paying taxes now that you didn’t need to.  Second, the question people have is, “If I don’t pay that tax now and instead got to keep those dollars invested, what would that grow to and does that offset the benefit of doing the conversion?”  In other words, is having extra tax-free money in the future worth paying taxes now when considering the time value of money? Time value of money is the concept that dollars today are more valuable than dollars in the future because dollars today may be invested and grow over time while dollars in the future are worth less due to inflation.  This is an extremely important concept and needs to be considered when making almost all financial decisions from Social Security to paying debt to investing in general. However, when it comes to Roth conversions this should not be considered.  For example, let’s consider someone making a $50,000 Roth conversion who is in the 20% bracket and will be for the rest of their life.  On that conversion they will owe $10,000 in taxes (20%) meaning the remaining $40,000 makes it into the Roth account.  Money in a pre-tax account and a Roth may be invested exactly the same so we’ll assume an 8% compounded return.  After 10 years, the $40,000 in the Roth grows to $86,357, which is all tax free.  The question though is what would that $10,000 have grown to if it didn’t have to be paid 10 years prior?  Well, if no conversion was done, all $50,000 would have remained in a pre-tax account growing at the same 8%, so after 10 years it would be worth $107,946.25, obviously more than the $86,357 in a Roth.  However, that $107k has not yet been taxed so if accessing it still costs the same 20% tax that would be $21,589.25, meaning the after-tax amount is… $86,357 or the exact same as we would have in the Roth.  What this means from a time value of money perspective is, since pre-tax and Roth accounts may have identical investments and returns, the present value of the tax on the conversion is the same as the future value of the tax if there is no conversion, assuming the tax rate is the same. In our example the future value of $10,000 is $21,589.25 assuming an 8% return over 10 years, which is true. Therefore, when considering a Roth conversion, it is not the time value of money that is relevant, but the tax rate during the conversion compared to the tax rate in the future.  In our example we assumed a consistent 20% tax rate which is not realistic.  Over time income levels and sources change as well as the tax rates themselves.  If Roth conversions are performed when the individual tax rate is lower than it will be when pre-tax retirement withdrawals are being taken, the conversion is helpful. For instance, if we think our retirement tax rate will be more than 20%, a conversion should be done now if it is 20%.

 

Companies Discussed: DraftKings Inc. (DKNG), Dollar General Corporation (DG) & Dell Technologies (DELL)

August 31, 2024|Inflation, Oil & Natural Gas, Rent Concessions, Business failures, Growth vs. Income Investing, Super Micro Computer, Inc.(SMCI), Sprouts Farmers Market (SFM), Advance Auto Parts(AAP)

Inflation report pretty much solidifies a rate cut in September

Personal consumption expenditures prices (PCE) were right in line with expectations as they increased just 2.5% in the month of July. Core PCE, which is the Fed’s preferred measure came in at 2.6% and was slightly below the estimate of 2.7%. While both readings matched the June inflation report, I would say inflation at around 2.6% is still extremely manageable and I believe we will continue to see it trend towards the 2% target as we exit the year. With these numbers I believe we will see the Fed cut rates by 0.25% at the September meeting and then we could see one or two more cuts before the end of 2024. 

 

Will oil and natural gas disappear over the next few years?

You may think that in a few years oil and natural gas will be a thing of the past, but Exxon believes the consumption of oil will be the same in 2050 as it is today and they don’t see carbon emissions dropping until the year 2030. In the report they do see the world demand for natural gas increasing by 21% by the year 2050 while they expect the demand for oil to increase by just 2%. They do point out most of the growth for these energy sources will come from the industrial sectors to fuel manufacturing and also from chemical feed stock. Exxon does believe consumption of biofuels, solar, and wind will continue to rise, but clearly, they believe natural gas and oil are still needed to help fuel our world’s energy needs. The big loser they believe is coal as they see that energy source dropping off 39% by 2050. To help with emissions, Exxon is largely turning towards carbon capture and hydrogen-based fuels. 

 

Rent concessions are climbing at apartment complexes!

We are now well into the second half of 2024 and as we have been saying for the past couple years we believe the overbuilding of apartment buildings will eventually put downward pressure on rents. According to Moody’s, rents are up 22% since 2019 across the country and the average rent is $1750, but due to the overbuilding of apartment buildings, landlords are having a hard time maintaining the higher rents and are now starting to offer concessions such as a month or two of free rent or a discount on utilities. Some of the more creative apartment companies have come up with cash rewards or gift cards to Amazon, CVS, Target or Walmart if you pay your rent on time. Don’t get too excited about the concessions. They may sound good, but be sure you do the math to find out how much you’re really saving. One large rental company says by offering a rewards program, about 97% of the renters renewed their lease in 2024. That is well above the national average renewal rate of 65%. I do believe over the next couple of years we should see rents decline somewhat as vacancies climb and these big rental companies have to pay the loans on all the construction costs, they incurred to build these apartments. Simply put, they will need the cash flow to make their debt payments.

 

Business failures have climbed this year!

Over the past year, starting a business has not been that easy. The number of failed new businesses increased by 60% as the new business owners ran out of money. Could this be because of a slowing economy? Bad business management? Or not having enough cash to start a business? Or perhaps it could be all three?

 

Growth vs Income Investing

The fundamental goal of investing is to make money, but for most people this is broken into two phases, growth and income. During working years everyone is saving and investing money, building their nest egg so during retirement, they can stop working and begin relying on income from their assets to support them. However, it is one thing to add money every paycheck to a 401(k) for 30 years, it’s another thing entirely to withdraw money from an investment portfolio every month for 30 years without running out. During the growth phase, the swings in the market aren’t as emotionally tolling because there’s a paycheck coming in every few weeks. When that paycheck stops and you’re selling positions to withdrawing money from an account during a market decline, things can go bad quickly. Not to mention nest eggs are largest in retirement, so a small percentage change is still a large dollar swing. The average retirement lasts over 20 years, but bear markets occur about every 4 years so retirees have to endure these periods multiple times. During a bear market if positions are sold at the wrong time, if the bear market lasts too long, if too much is withdrawn, or if the investments aren’t sound, the portfolio will not have enough remaining funds to recover. Again this is not a risk during the growth phase when funds are begin added, not withdraw. To prevent against volatility risk in retirement, a lot of people shift their investments to something overly conservative, which short term feels safe, but long term will not produce the growth necessary to keep up with inflation and prevent outliving money. Before actually retiring, it is necessary to get comfortable with an investment philosophy that will continue to provide growth but will also allow sustainable withdrawals through the ups and downs of the market. Mistakes made early in retirement can result in the need to return to work or heavily reduce your lifestyle which no one wants to do after spending decades looking forward to retirement.

 

Companies Discussed: Super Micro Computer, Inc.(SMCI), Sprouts Farmers Market (SFM), Advance Auto Parts(AAP) 

Robo-Advisors, Inflation, Strategic Petroleum Reserve, Debt, Gold, SBUX, Tesla, Housing Prices, & Annuities

History shows robo-advisors failed to live up to the hype!

When robo-advisors first came out years ago, people asked if I was worried about my career. I said no because I do believe that investing can be very complicated and a good advisor is worth it. I’m happy to report that has been the case. Robo advisors have only accumulated one trillion dollars in assets, that is only 2% of the entire $50 trillion advisory market. JPMorgan Chase and Goldman Sachs both dropped their robo-advisor programs because their clients didn’t feel the low cost provided what they needed. Low costs were the initial selling point for robo-advisors but today most have added some human interaction. With that costs have increased and these hybrid services can now cost around 0.65%. In my opinion, that is still not a great option because you won’t get a personal advisor and instead you will be left with a team of people who really don’t know your situation. The biggest problem I have seen with the robo-advisors has been when things get difficult, investors have no one to talk to and they end up selling at the wrong time. When it comes to performance, I think most investors have found that the lower fees did not produce the results they had hoped for. Over the last five years, the best performing robo-advisor based on a 60/40 portfolio was Sofi Automated Investing with a 7.8% annualized return. Schwab pulled up the rear with their Schwab Intelligent Portfolios showing a five-year annualized return of only 5.8%. It’s important to point out these numbers are only if the investor stayed in the program for five years straight. Sometimes automation can be great, but there are just certain areas of life such as your health and financial well-being that you need a good professional on your side to talk to when you need. 

 

A look into the history of inflation data 

Whether we’re talking about the CPI or the PCE, it seems no one is happy with how inflation is reported. I tell people your personal inflation is the most important inflation to understand as it is based on what you’re spending habits are rather than looking at someone else’s. A good example is a college student has far different expenditures than a retired senior. The Bureau of Labor Statistics released its first CPI number in February 1921 and that report included data going back to 1913. Time has changed consumer inflation as spending and prices have changed overtime. From 1935 through 1939, food represented 33.9% of a household’s expenses, today it is only 13%. During the depression, apparel was hard to come by and it was 11% of a paycheck. Today it only represents 2.6%. Many items are not comparable as time and style has changed. For example, cars and radios weren’t common enough to be included in the earliest years and now radios have become a dying product. There are some items though that we can look back over history and come. In 1913 round steak was 22.3 cents a pound which is equal to about $7 today. This would be below the price of $8.25 in the month of May. Butter was hard to come by and cost 38.3 cents a pound. That would be around $12 a pound in today’s dollars versus the May average of around $4.60. I will agree the CPI and even the PCE are not the best or should I say an exact measurement that people may want, but keep in mind the Bureau of Labor Statistics surveys metro area businesses and households collecting 94,000 prices and 8,000 rental housing unit quotes per month. So while it is a difficult task to take on, it is not just one person throwing out numbers but an accumulation of a lot of data that has been compiled for over 100 years. There will never be a perfect system for measuring inflation, but as of now they have not been able to find a better way to calculate it.

 

The Strategic Petroleum Reserve has remained at low levels

Oil currently trades around $75-$78 a barrel but the uneasiness in the Middle East should cause concern about the level of our Strategic Petroleum Reserve (SPR). The government used part of that reserve back when oil was $100 a barrel to try and keep the price of oil low, but they have never tried to replace it. We are currently sitting at a 41 year low on the SPR and I have to ask excuse the language, What the hell are we doing? Yes, the United States is currently pumping a lot of oil, but if there were a worldwide supply disruption that would then increase the price of oil around the world. The current administration should’ve been taken advantage of the low prices. We have had oil low for quite a while now and should have been buying a little bit at a time. For some reason the administration has chosen not to do that. I think this is a mistake and I do believe that if we don’t do something soon, we have the potential for some major problems with our energy security here in the US. 

 

The US government is issuing too much short term debt over long-term debt

We have said many times that we’re not that concerned with the overall debt of the US government because a true balance sheet shows we will be OK. However, that doesn’t mean that the current way we are financing that debt is correct. What concerns me is we are issuing too much short term debt versus long-term debt and that in the future the country will be at the mercy of short term interest rates to finance our large debt of $36 trillion. What should be happening is the government should be issuing more longer-term debt to lock in lower rates, just like you would on a mortgage. The concern is if they were to do that, it could cause long-term rates for consumers to increase. What appears to be happening is that the Federal Reserve will cut interest rates and short term rates will fall, but there should be a spread of around 2% from a short term rate to a 10 year treasury. If short term rates fell to a reasonable 3% that would put the 10 year treasury around 5%. It could cause some short term pain, but that’s far better than having a big portion of our $36 trillion debt in short term maturities. If short term rates were to skyrocket so would the interest cost and that would create more problems.  

 

Why is gold hitting new highs?

Last week gold surpassed $2500 per ounce, which is an all-time high for the precious metal. Many people thought with high inflation in 2021, 2022, and 2023 gold would have appreciated then, but it actually did very little as the ETF GLD was up just around 10% from the beginning of 2021 through the end of 2023. Something else that moves gold is the strength of the US dollar, which is starting to decline. The reason for the decline in the US dollar is because it does appear that interest rates are coming down. This generally leads the world to buy more gold. 2024 has been a great year for gold as it is up over 20% and while it may have some more appreciation going forward, you will still not find it in our portfolio. I still think there are some good value companies out there that are paying good dividends and that will outperform gold.

 

Can Starbucks (SBUX) hold on to the recent 25% jump in their stock price?

After the news that Starbucks hired Brian Niccol, the CEO from Chipotle, was released, the stock climbed 25%. The question is… can that higher stock price last? Under Brian‘s management at Chipotle, the stock climbed over 700%. Prior to being the CEO of Chipotle, he was the CEO for Taco Bell. They say being at the right place at the right time can help. When he first took over Chipotle, the company was having reputation problems, customer traffic issues, and their stock was struggling from the E. coli and norovirus outbreaks. He came in when the stock was trading at extreme lows and while I believe he did a great job, there was a lot of negativity priced into Chipotle’s stock. It’s important to understand how much larger Starbucks is and what a different business than Chipotle it is. It operates with 10 times as many stores, a large international business, and it has a packaged food business. I do believe that Brian Niccol has taken on a large order with his new role at Starbucks!

 

Tesla may be further ahead in self driving then I was aware of

On October 10th of this year, Tesla will be holding a robotaxi event for investors. I have said before that the Cruise division from General Motors and the Waymo division from Alphabet are far ahead on public testing for their driverless cars compared to Tesla. I recently saw an article in Barron’s that showed data from Tesla that their software has accumulated over 1,500,000,000 miles. The question is will the government accept this software data or not. The government has come down very hard on both General Motors and Alphabet, let’s see how they handle Tesla. 

 

The million-dollar home is just not as special as it used to be 

Living in San Diego many “normal homes” have surpassed the $1 million mark, but nationwide that trend has also been increasing. In 2023, 7.6% of US homes had a value of $1 million or more. In 2024, that number has now climbed to 8.5% of US homes. That is nearly a 12% increase for $1 million or higher homes. I just don’t see how the price of homes can keep increasing at such a pace when incomes are not keeping up and affordability continues to remain a major problem.  

 

Could a potential overbuild of apartments help with housing prices?

We have talked many times about the potential overbuild of apartment complexes and now as more projects are finishing, it appears we are finally seeing an impact on pricing. In the month of June, more multifamily units were completed than in any month in nearly 50 years. This is leading to more recent concessions as 33.2% of U.S. landlords offered at least one rent concession. This was up from 25.4% last year. The increased supply also led to a decline in the median asking price for apartments in one- to three- bedroom units in the month of July. This marked the first decline since 2020. According to Redfin data, the median asking rent price for a studio or one-bedroom apartment fell 0.1% to $1,498 a month; two-bedroom apartments decreased 0.3% to $1,730; and units with three bedrooms or more, were down 2.4% to $2,010. I believe this is a major positive as it could help control home prices if renting is a more cost competitive option. It should also be a huge benefit to inflation as CPI has continued to see a major negative impact from high shelter costs.

 

Can Annuities Lose Money?

Annuities are often associated with high fees and limited growth, but in exchange they come with guarantees like lifetime income and downside protection. This begs the question “can they lose money?”, and the answer is “absolutely”! There any many types of annuities and depending on how they are structured and the underlying investments, they can and do lose money despite being conservative. We met with someone this week who purchased an annuity three years ago for about $580,000. Now, even though the market has gone up during that time period, the annuity is worth less than $560,000, not including any surrender charges. How could this product lose $20,000 when most of the market overall is positive? Well, this was a variable annuity which means the account value is invested in a variety of mutual funds. When the annuity was purchased, the agent selected some funds that didn’t do too well. On top of that this annuity came with an income rider that includes an additional fee that is deducted from the account balance, further hurting performance. This rider comes with a separate income base that grows at a non-compounded 5% per year, and at annuitization will pay out 3.5% of the income base for life. Basically, this means even if the account balance itself doesn’t grow, guaranteed income can still be available from this income base. However, when you look at what this translates too, it does not seem attractive at all. This guy purchased the annuity when he was 58. If he starts collecting lifetime income at 65, he will be over 86 years old before he gets back the money he put in when he was 58. Technically this income is guaranteed for life, but with the fact that a low-interest checking account would have better performance over 30 years, the “guaranteed” benefit loses most of its appeal.

 

Companies Discussed: Brinker International (EAT), Intuitive Surgical (ISRG), Cisco Systems (CSCO)

August 17, 2024 | Declining CPI, Retail sales data, separately managed funds, Umbrella Insurance, JB Hunt Transport Services (JBHT), Mobileye (MBLY) & Ulta Beauty (ULTA)

Declining CPI opens door to lower interest rates

Inflation concerns are falling as the July Consumer Price Index (CPI) showed an increase of 2.9% compared to last year, this would mark the lowest reading since March 2021. Core CPI, which excludes food and energy was also positive as it came in at 3.2% which would mark the lowest reading since April 2021. Areas that continued to put upward pressure on inflation included food away from home (+4.1%), electricity (+4.9%), and motor vehicle insurance (+18.6%). Other areas that used to be problematic have now reversed course and are benefitting the inflation report. This includes used cars and trucks (-10.9%) and new vehicles (-1.0%). Shelter continues to be the heavyweight in the report as the category increased 5.1% compared to last year and accounted for over 70% of the increase in core CPI. If shelter was stripped out, CPI would have increased just 1.7% compared to last year. I believe we’ll continue to see further progress on inflation as we end the year.

 

Retail sales data shows people are still spending money

Data points continued to come in favorably for the Fed this week as retail sales increased 1.0% compared to last month. This easily topped the estimate of 0.3%. Looking compared to last year, retail sales were up a healthy 2.7%. Nonstore retailers continued to see strong growth with a 6.7% gain compared to last year and while growth has slowed, food services and drinking places still showed good growth of 3.4%. It appears both electronics and appliance stores and building material & garden equipment & supplies dealers have bottomed with gains of 5.2% and 0.4% respectively. This is the first time I remember seeing a positive gain in building material & garden equipment & supplies dealers in a long time. Furniture & home furnishing stores did remain a drag on the report as sales declined 2.4% compared to last year. Overall, I believe this was a great report considering we are seeing inflation slow and the consumer is still willing to spend. The soft landing many have wondered about is looking more and more possible with reports like this.

 

Are separately managed funds best for you?

At Wilsey Asset Management, we manage all our accounts separately and have done that now for over 30 years. What that means is our clients actually hold the securities in their portfolio versus buying shares in a mutual fund or ETF. This trend seems to be taking hold with other brokers as asset growth for separately managed accounts (SMAs) has been 30% over the past two years. SMA’s are now at $2.4 trillion in assets in professionally managed accounts. This compares to $4.3 trillion in mutual funds and $1.9 trillion in ETF’s. These managed accounts will generally use an outside money manager and it will not be quite as individualized as people would prefer. One thing to understand is the fees considering you are likely paying you’re an advisor/broker a fee and then an additional fee to the SMA manager. Often times this strategy can cause confusion for the investor as well, sometimes we have seen this strategy produce 50 to 100 positions which can also be a nightmare to get out of. Lastly if you have questions on why certain positions are in the portfolio you will not be able to call and talk to the person making those investment decisions and you’ll be stuck with a pre-scripted response from the broker. Be sure to ask your broker/advisor many questions if they are advising SMAs as it may sound better than it really is.

 

Financial Planning:

When to get Umbrella Insurance

Both home and auto policies contain liability coverage, which pays in case you are sued for damaging property or if you are responsible for hurting someone.  An example could be someone slipping on your driveway, but more commonly it is due to a bad car accident.  An umbrella policy adds extra liability coverage that kicks in after the home and auto liability is exhausted.  In recent years, litigation across the board has been rising, but also inflation has increased the cost of medical bills and auto repairs.  This in turn has resulted in more umbrella claims as costs are more likely to exceed the coverage on home and auto polices alone.  As a result, insurance carriers have increased premiums on umbrella policies (as well as home and auto policies) and have been more likely to deny umbrella coverage increases or coverage all together.  Even with these cost increases, it is still relatively affordable at a few hundred dollars per year, so if you are underinsured you should consider purchasing a policy.  Umbrella coverage comes in increments of $1 million, and the rule of thumb is to carry insurance equal to your net worth.  However, this can be excessive in some circumstances as assets like qualified retirement accounts and home equity have some protection against lawsuits. Generally speaking, if your net worth is over a million, you should have an umbrella policy, and depending on your net worth, the types of assets you own, and your exposure to liability, you may need to carry higher amounts of coverage.  The last thing you need after building a nest egg is for an unexpected lawsuit to take all your assets and put you back to square one.

 

Companies Discussed: JB Hunt Transport Services (JBHT), Mobileye (MBLY), Ulta Beauty (ULTA)

August 10, 2024 | Friendly Fraud, Google & Apple, US Debt, Tax Changes in 2026, Intel (INTC), Merck (MRK), Charles Schwab (SCHW)

“Friendly fraud” is costing businesses $100 billion a year

I was surprised to learn of a new term called friendly fraud. This is when a customer disputes a legitimate charge they made on their credit card, debit card, or another payment method. According to a recent survey,35% of Americans admit to committing this kind of fraud, and 40% know someone who has. This has come at a huge cost to merchants as it is estimated to cost them $100 billion per year. Some of the fraud is accidental as it can come about when a consumer doesn’t recognize the merchant’s name used to identify a purchase on their bill. Sometimes a merchant will have a name that differs from their commonly known name. If you are a merchant, you may want to look into this as it could help save you some of these potential costs. Of those that committed this type of fraud, 29% said it was accidental. Other reasons for committing this type of fraud included economic hardship (34%) and respondents knew someone else who had gotten away with it and then gave it a try (19%). I have to say, if you have intentionally done this, it is just wrong. It is really no different than walking into the store and stealing. Ultimately, this costs other people as merchants will need to charge more for their goods to offset these costs.

 

Google’s monopoly ruling could be a huge loss for Apple

This might sound crazy, but I believe the ruling by a federal U.S. judge that Google has illegally held a monopoly in search and text advertising might have a bigger impact on Apple’s stock than Alphabet’s. This case was filed in 2020 by the Department of Justice and a bipartisan group of attorneys general from 38 states and territories. It alleged that Google has kept its share of the general search market by creating strong barriers to entry and a feedback loop that sustained its dominance. The court found that Google violated Section 2 of the Sherman Act, which outlaws monopolies. In the ruling, the court focused on Google’s exclusive search arrangements on Android and Apple’s iPhone and iPad devices, saying that they helped to cement Google’s anticompetitive behavior and dominance over the search markets. This should be a major concern for Apple considering Google paid them $20 B in 2022 and if we annualize the recent service revenue in Q3 of $24.2 B the Google payment would account for about 25% of service revenue. I can’t imagine there are many costs associated with this for Apple, so the loss of this payment would essentially subtract $20 B from total profit. For Google the risk is that users might have other options for search engines, but with their strong reputation and well-run platform I don’t think they would lose a lot of users. 

 

The US debt continues to climb, should you be concerned?

If you haven’t heard the news already, you probably will hear it as time goes on, the US treasury estimates America’s gross national debt at $35 trillion which was hit last week. No doubt about it, $35 trillion by itself is a scary number. But this number is only half the story. In accounting, a balance sheet has assets and liabilities. To know the total equation, one needs to know what the assets are for the United States government. It is estimated the government has assets of $178 trillion which is made up of real estate, oil and natural gas rights and other assets. It is also important to know that much of the real estate was bought many many years ago and is carried at book value, not the current value or market value. Taking it one step further and looking at the debt-to-equity ratio, the government would have a debt/equity of 24.5%. This is not a bad ratio at all and I’m sure many people across the country would love to have a personal debt ratio that low. So when you hear people complain about the debt, ask them what are the assets and their value? Most people don’t have a clue! Thank you to most of the mainstream media that only wants to scare you, rather than educate you by giving you the whole story!

 

Financial Planning:

Tax Changes in 2026

The Tax Cuts and Jobs Act of 2017 contained quite a few changes for federal taxation, but some of the more impactful differences were the tax rates themselves, the ranges of income that is subject to the tax rates, and the adjustment to deductions and exemptions. These went into effect in 2018 and are expected to sunset back to their original rules in 2026. We are now in 2024, so we only have 2 tax years left. There are 7 federal tax brackets which currently are 10%, 12%, 22%, 24%, 32%, 35%, and 37% and these are expected to increase back to 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. This is one of the more well-known adjustments, but one of the lesser-known features is that the amount of income subject to each of those tax rates will be adjusting as well. Essentially this means the same level of taxable income will climb into the higher tax brackets more quickly beginning in 2026. In other words, you may fall into the 3rd tax bracket right now, but after the sunset, you would fall into the 4th tax bracket with no other changes to income. These tax rate and income range changes are both bad for your tax bill as they will increase tax lability in 2026. Alternatively, there is also the change to the standard deduction, itemized deduction, and exemptions which may be helpful for your tax bill in 2026 and beyond. Between 2017 and 2025, the standard deduction was increased, limits were placed on itemized deductions, and exemptions were eliminated. Based on your situation, the net impact of this is either a larger or smaller level of taxable income, which is what is subject to the tax brackets. Many people currently claim the standard deduction, but itemizing will again become more common in 2026 which results in lower levels of taxable income. What’s funny is most people aren’t familiar with how taxes work or how much they actually pay, they just know they pay “a lot” or “too much”. Consequently, people seem to let their opinion of former president Trump dictate whether they are in favor or not of these tax changes as he was largely responsible for them. We’ve seen people who love Trump and thought they got a tax cut, when their tax bill really didn’t change much, and we’ve seen people who hate Trump thinking their taxes increased when really, they didn’t. Every situation is different but generally people with lower levels of income will see a tax increase in 2026. This is because most low-level income earners do not itemize which means they will have a higher taxable income that is taxed at a higher rate. People with higher levels of income will either see relatively no change, or a tax increase in 2026 as they will likely itemize resulting in lower levels of taxable income but will be subject to higher tax rates. People who claim the standard deduction and who are in the middle tax brackets will likely see an increase in taxes in 2026 as their taxable income will be higher and will be taxed at higher rates. People who will itemize and who are in the middle tax brackets will either see not much of a tax change in 2026 or will see a tax decrease. People who are more likely to see a tax decrease are those in the third or fourth tax bracket living in a high-income tax state and who have a house with a mortgage with higher property taxes. This is because they will have a higher level of itemized deductions from the extra state income and property taxes, but their income is low enough so they aren’t pushed too far into the upper brackets. Overall, the majority of people, even in California, will either see relatively no change or a tax increase in 2026, but there are a few who will see a tax decrease.

 

Companies Discussed: Intel (INTC), Merck (MRK), Charles Schwab (SCHW) 

August 3, 2024 | Employment Numbers, Venu Sports, Microsoft vs. Open AI, SoFi Technologies (SOFI), UPS (UPS) & DexCom (DXCM)

Did the markets overreact to employment numbers?

Markets headed largely lower Friday morning after nonfarm payrolls grew by just 114,000 in the month of July. This was well below the estimate of 185,000 and the downwardly revised June number of 179,000. Total revisions for the previous two months led to numbers that were 29,000 lower than previously reported. The major concerns here are that job creation is well below the average monthly gain of 215,000 over the previous 12 months and the unemployment rate has now ticked up to 4.3%, its highest since October 2021. This triggered fears over the Sahm Rule, which states the economy is in recession when the three-month average of the jobless level is half a percentage point higher than the 12-month low. The three-month unemployment rate average has now moved up to 4.13%, which is above the 3.5% level in July 2023. Frankly, with unemployment as low as it’s been, I don’t believe this rule provides a strong signal here. As for the lower payroll numbers, it should be expected after years of expansion that job growth would slow. I don’t believe that means we are heading into a recession considering it is just one month of data and it still showed positive gains in the month. On the positive side, inflation concerns should be helped here considering wage inflation grew 3.6% from over a year ago, which was below the estimate of 3.7% and last month’s reading of 3.9%. While this wasn’t a great report, I don’t believe there is much to panic about here. 

 

The Job Openings and Labor Turnover Survey (JOLTs)

The Job Openings and Labor Turnover Survey (JOLTs) showed job openings totaled 8.18 million in the month of June. This was a bit higher than the estimate of 8.1 million, but lower than May’s upwardly revised reading of 8.23 million. The ratio of openings to unemployed workers still stood at very good rate around 1.2 to 1. I don’t think this report will move the Fed’s thinking for rate cuts one way or another as it shows a softening labor market that remains near a healthy level.

 

I’m not that impressed by the new sports streaming service Venu Sports.

Venu Sports is the joint venture between Disney’s ESPN, Warner Bros. Discovery and Fox. It will feature all three companies’ portfolio of live sports. This includes the NFL, NBA, NHL, MLB, and college football. The service will cost $42.99 a month. The joint venture is aiming to launch before the start of the NFL season on September 5th, but it is still pending regulatory approval. It is also expected for further details to be released when it launches. My problem here is there are still so many sports games you are not receiving and $42.99 a month is quite expensive. Consider the fact that now Amazon, Apple, Alphabet and Paramount also own large sports rights. One thing I’ll be interested in is how expansive the service will be. For example, with the NFL on Fox you are only able to view the local Fox game that is being broadcasted. With this new service would I be able to watch any NFL game that is being broadcasted on Fox that day? If not, I really don’t believe this is worth the money. As for the business structure it will be interesting to see how it plays out. Each company will own a 1/3 stake, have equal board representation, and will continue to bid independently for sports rights. I find it interesting they have an equal share since they all bring different rights to the table. As it stands right now, I’m not a fan of this deal as a consumer nor would I be as an investor in one of these companies.

 

Are Microsoft and OpenAI going from partners to competitors?

In Microsoft’s recent annual report, it added OpenAI to its list of competitors. This list has included companies like Amazon, Apple, Google, and Meta, but OpenAI was a new major addition. The competitive landscape in AI continues to evolve and with the launch of OpenAI’s search engine known as SearchGPT last week, the two companies are now competing directly in the search space. Remember when OpenAI was supposed to revitalize Microsoft’s Bing search engine? It doesn’t look like that will pan out. Microsoft said they are also competing with OpenAI in AI offerings and news advertising. After investing a reported $13 B in OpenAI, Microsoft is the biggest investor. The company also serves as the exclusive cloud provider for OpenAI and uses its AI models in its products. I would say this relationship is definitely looking more and more confusing, especially when you consider OpenAI’s business model. According to their website, OpenAI operates as a partnership between the original Nonprofit and a new capped profit arm. I would say this definitely complicates how Microsoft will be able to monetize its investment. As for AI, while I still believe it will have an impact on our society, it’s just too early to try and pick winners and losers in this complicated space.

 

Planning for the Expected and Unexpected

A lot of people associate financing planning with “goal planning” such as preparing for retirement, a home purchase, or education costs, but life has a way of going in unexpected directions. It is equally important to take the steps necessary to prepare yourself in case the unexpected happens, because it inevitably will. This could be an illness, disability, job loss, death, divorce, income reduction, or anything else that negatively impacts your financial situation. Just because you don’t know what’s going to happen, doesn’t mean you can’t plan for it, and you want to have contingency plans in place so a bad situation doesn’t become catastrophic. Some examples would be making sure you have an established emergency fund, also having additional liquid assets or access to credit, making sure you have the right types of insurance and the appropriate levels of coverage, spending that is under control, and not being over-leveraged at any given time. These aren’t necessarily moving you in the direction of your goals, but they do keep you from going backward. I spoke to someone recently who’s in their early 30’s, has four kids and a wife that stays home with them, so he’s the bread winner. It looks like the company he works for might be going bankrupt and he could be losing his job. So far he thought he has been doing to right thing by buying a home and saving toward retirement, but all their money is tied up in retirement accounts and their house, which doesn’t have a lot of equity, so there’s not a lot of funds to access if he suddenly loses his income. They may need to withdraw from their retirement accounts in which case the tax and penalty consequences will greatly outweigh the benefits they got by funding them. Hindsight is 20/20, but this is an example of what can happen and why you want to be prepared. Financial planning is about making the right decisions on a consistent basis to accomplish your goals, but it is also important to make sure you are in a position to handle whatever comes at you, good or bad. When opportunities come along, you want to be able to take advantage of them. When something bad happens, you want to be able to take care of it without it derailing your financial situation or lifestyle.

 

Companies Discussed: SoFi Technologies (SOFI), UPS (UPS) & DexCom (DXCM)

July 27, 2024 | Q2 GDP, June PCE, WBD vs NBA Legal Battle & IRS and Inherited IRAs

Q2 GDP not as strong as the headline numbers show

While Real Q2 GDP increased at a 2.8% annualized pace and easily topped the estimate of 2.1%, there were some likely one time impacts that lifted the numbers. The major outlier was the change in private inventories as it added 0.82% to the headline GDP number. As we discussed after Q1 GDP, private inventories negatively weighed on GDP during that quarter as it subtracted 0.42% from the headline number and led to a disappointing growth for Real GDP of 1.4%. Government also saw a nice boost as it grew 3.1% in Q2 and added 0.53% to the headline number. Even though the report may not be as strong as the headline shows, I still believe it was a good report. Personal consumption expenditures grew 2.3% in the quarter as spending on goods was up 2.5% and spending on services was up 2.2%. Spending was different when compared to Q1 considering in that report goods spending fell 2.3% and services spending rose 3.3%. Private investment was also strong in Q2 as it rose 8.4%. Although residential was down 1.4%, nonresidential investment was up 5.2%. Equipment was the strongest subcategory as it was up 11.6% and intellectual property products also saw good growth of 4.5%. Trade was the only component that subtracted from the headline number. The increase in imports of 6.9% more than offset the increase in exports of 2.0% and led to a subtraction of 0.72% from the headline number. I believe this GDP report is exactly what we needed to see for a potential soft landing. We are still seeing growth of around 2%, but it is slowing which should help reduce inflation in the coming months. 

 

June PCE

Inflation continues to normalize as the June personal consumption expenditures index (PCE) increased 2.5% from a year ago. Core PCE, which is the Fed’s preferred measure showed an increase of 2.6%. Both numbers were in line with expectations and they provide more evidence that an interest rate cut should be heading our way as we exit the year. This report does put more pressure on the Fed to provide a signal for fed policy direction at next week’s meeting. I don’t think there will be a cut at that meeting, but the market appears to be hoping that they at least hint towards a cut in September. 

 

Legal battle between Warner Bros. Discovery and NBA is set to begin

The NBA announced deals with Disney, Comcast and Amazon for rights to games for 11 years starting in the fall of 2025. The deals totaled around $77 B with Disney paying around $2.6 B per year, Comcast paying around $2.5 B per year, and Amazon paying around $1.9 B per year. These deals also include the rights for WNBA games. The current rights that will expire next season were for 9 years and nearly $24 B. Disney will air more than 20 games per season on ABC and up to 60 games on ESPN. NBC will air 100 NBA games each season, including about 50 that will be exclusive to Peacock. NBC is returning as a partner with the NBA after losing rights in 2002. Amazon will offer 66 regular season games. This was a major disappointment for Warner Bros. considering Turner Sports has carried live NBA games for nearly 40 years. This spells more trouble for TNT and TBS as this was a major asset for these stations. The popular “Inside the NBA” show on TNT is also in question if Warner Bros. is unable to win back the rights. Warner Bros did acquire matching rights as part of the current deal, but the NBA rebuffed the bid and said, “Warner Bros. Discovery’s most recent proposal did not match the terms of Amazon Prime Video’s offer and, therefore, we have entered into a long-term arrangement with Amazon.” It will be interesting to see how this shakes out. The NBA doesn’t believe Warner Bros. rights extend to an all-streaming package, which was carved out for Amazon. The last time these deals were made I can’t see how streaming would have been addressed. For that reason, my early inclination would be that it would be hard for the NBA to deny Warner Bros. their matching rights. 

 

The IRS and Inherited IRAs

After 5 years, the IRS has finally come to a decision with inherited IRA withdrawals. The Secure Act in 2019 removed the ability for most retirement account beneficiaries to stretch distributions over their life expectancy and now requires them to fully deplete the account after 10 years. With tax-deferred accounts, this severely limits compounding growth and increases the income tax burden on these beneficiaries. The component that has been up for debate is whether those beneficiaries also have to take required distributions during each of those 10 years. So far, no distributions have been required and a few days ago the IRS confirmed that a distribution will not be required in 2024. However, beginning in 2025, beneficiaries who inherited a tax-deferred retirement account in 2020 or later from someone who was subject to RMDs (which will be most cases) must begin taking small required distributions of their own each year as well. This does not apply to beneficiaries who are spouses, minors, or disabled, and while inherited Roth IRAs are subject to the 10-year rule, they will not have annual required distributions. Keep in mind, if you inherited an IRA in 2020 and wait until 2025 to start distributions, you now only have 6 years left to deplete it because you are still bound by the 10-year rule. This means larger annual distributions and maybe higher tax brackets. So even though you don’t have to start, that doesn’t mean you should continue to wait or that you should only take the minimum amount required. Every beneficiary should have their own plan on how best to distribute the funds at the lowest tax rate which will be dependent on their own income level, retirement date, level of their own retirement assets, and the fact that tax rates could increase in 2026. This could mean accelerating or deferring inherited withdrawals so they occur when your own income is lower.

 

Companies Discussed: Bank of America (BAC), Dominos (DPZ) and UnitedHealth Group (UNH)

Jul 20, 2024 | Retail Sales, Oil Demand, Japan's Pension Fund and Spousal Social Security

Retail sales beats expectations but shows consumer is still softening.

June retail sales came in flat compared to the previous month, this topped the expectation for a 0.4% decline. Compared to last June, retail sales were up 2.3%. Areas of strength included non-store retailers (+8.9%), food services and drinking places (+4.4%), clothing and clothing accessories stores (+4.3%), and electronics and appliance stores (+2.7%). Both furniture and home furnishing stores (-4.0%) and building material and garden equipment and supplies dealers (0.9%) were done when looking year over year, but they have perhaps started to turn the corner as they both showed month over month gains. Gasoline stations were also a negative weight as it was down 3.0% compared to last month and 0.4% compared to last year. Overall, I believe this is a strong report that shows an economy that is slowing but remains in a healthy place. With this news and other comments from Fed chair Powell markets have now priced in a 100% chance of at least one rate cut by the September meeting. 

 

Will oil demand increase or decrease in years to come?

I have been concerned about oil consumption and investing in oil related companies based on the increase in electric and hybrid vehicles. Unfortunately, there’s not much help in predicting oil demand from the experts. British petroleum, also known as BP, expects oil demand will plateau by 2025. They believe the subsequent decline will depend on how aggressive countries get with carbon omissions. BP believes by 2050 oil demand could drop down to 25 million to 30 million barrels a day if countries get serious about a “net zero” goal. This would be a major decline from today’s level of about 102 million barrels a day. But there’s others who disagree such as OPEC which sees demand growing by 4.1 million barrels a day from 2023 to 2025 and continuing to rise at least through 2045. The Paris-based International Energy Agency forecasts a peak in 2029 and the US Energy Information Administration is looking for peak between 2030 and 2040. It also looks like Warren Buffett does not believe a peak is coming soon as he has been investing heavily into Occidental Petroleum and has a sizeable stake in Chevron. With all the uncertainty, I believe if an investor is going to invest in an energy company, it should be a well-diversified. 

 

Japan’s $1.5 trillion pension fund could be a black Swan for our stock market.

Japan has grown their pension fund to $1.5 trillion over the years and has continued to increase the amount of money they invest in the US. As of March 31st, about 50% of the fund was held in foreign stocks and bonds, most of which was in the United States. The problem they have is their currency, the yen vs the dollar has fallen to levels not seen since President Reagan was in office. The investments in foreign countries have led to some criticism as some say it amounts to a vote of no confidence by the Japanese government in its own currency. It is unknown what US equities they hold, but the fund was up 23% in its most recent fiscal year. My concerns are what if they want to reduce their exposure to US equities and bonds to 30%? That would be a reduction of around $300 billion. What if they hold in their pension the high-flying technology companies? How would those stocks perform if the fund sold $100 to maybe $200 billion worth of stock? No one knows for sure, but with that 23% gain there is a high likelihood that they had a portion perhaps a good portion of the investments in the US technology companies. 

 

A Major Mistake with Spousal Social Security

When collecting Social Security on your own work history, you may collect between the ages of 62 and 70. Every month you wait, your benefit amount increases. In cases where one spouse did not work, or had a very limited earnings history, that spouse may qualify for a larger spousal benefit from Social Security. The maximum spousal benefit is one half of the higher earning spouse’s full retirement age benefit amount, and the lower earning spouse would need to collect at their own full retirement age to receive it. If this half is more than what they would receive from their own earnings history, they will receive the larger spousal benefit, not both. If they collect before their full retirement age, they will receive a reduced amount. Also, the higher earning spouse must be collecting for the lower earning spouse to be able to collect a spousal benefit. Many people have the idea of deferring their Social Security until age 70 so they receive the highest possible monthly amount. This strategy may not be the best decision normally, and it can be even more problematic when a spousal benefit applies. I met with some people this week who had this idea. One spouse worked and the other did not, so a spousal benefit was definitely going to be applicable. The problem is, a spousal benefit does not get any larger beyond full retirement age, which in this case was age 66 and 10 months for both of them. They were both the same age, so if they had waited to collect until 70, the lower earning spouse would be deferring 38 months (from 66 and 10 months until 70) for no additional benefit. In this case the spousal benefit was about $1,900 per month so whether she collects at 66 and 10 months or waits until 70, she would still receive only $1,900. This mistake would have cost them over $70,000 in missed Social Security benefits. Fortunately, they had not reached their full retirement age yet and the working spouse had not retired, so they had not lost anything yet. If you will be receiving a spousal benefit from Social Security it is almost never helpful to defer beyond your full retirement age, which is usually around age 67. 

 

Companies Discussed: CrowdStrike (CRWD), Amazon (AMZN) and PepsiCo (PEP)

July 13, 2024 | Inflation & Rate Cuts, PPI, Labor Market, Investing and Roth Conversions

Inflation continues to cool, creating more hope for rate cuts.

The June Consumer Price index (CPI) rose 3.0% compared to last year, which was below last month’s reading of 3.3% and the expectation of 3.1%. Core CPI, which excludes food and energy rose 3.3% from a year ago. This was below last month’s reading and the expectation which were both 3.4%. This also marked the smallest annual increase in core CPI since April 2021. Food was up 2.2% over the last 12 months with food at home up 1.1% and food away from home up 4.1%. Energy was up 1.0% as gasoline was down 2.5% and electricity was up 4.4%. Motor vehicle insurance continued to be an outlier as it was up 19.5%. The shelter index also continues to be a problem for inflation as it was up 5.2% and accounted for nearly 70% of the 12 month increase in core CPI. While this is off the peak of around 8%, the shelter index continues to lag real time data considering the annual inflation rate for new rental contracts fell 0.4% in the first quarter this year. This was down from the record highs around 12% just two years earlier. Part of the reason for the lag in the shelter index is the government constructs it by sampling a “staggered panel” of renters and homeowners. It splits the sample into six groups, and surveys each on a staggered basis every six months. I do believe this means we will continue to see shelter fall, which should be a major positive for the inflation rate. With this report I believe the chance for two rate cuts before the end of the year is now more likely. 

 

Producer Price Index disappoints against expectations

The Producer Price Index (PPI) rose 2.6% in the month of June, which was above the expectation of 2.3%. Core PPI rose 3.0% in the month, which was above the expectation of 2.5%. Although this looks troubling, I still believe these rates are manageable, especially considering the several months of positive data when compared to the CPI. I don’t think this report should be cause for concern, but it should definitely be monitored in the months ahead. I’m still looking for both core CPI and PPI to head closer towards the 2% target as we exit 2024.

 

The Labor Market Can be Confusing, Which Survey Should You Trust? 

We received the job numbers last Friday and lately there have been big differences between the establishment survey and the household survey. Because of these major differences, some people say these numbers are not worth relying on. But if one understands why the two are different, it justifies that the establishment survey is the one to follow. The establishment survey/nonfarm payroll number comes from employers who detail how many employees are working at their company. The household survey is completed by asking households who is currently working in their household. We have seen an increase in undocumented workers and when these people receive a call from any US government surveyor, they do not want to answer any questions for obvious reasons. This has likely led to part of the discrepancy between the two surveys. I believe businesses will provide a more accurate picture of labor market over a simple household survey. I especially think this is true when you consider the household numbers are based on surveys of approximately 60,000 households. These household responses are then used to calculate the numbers for the entire US population. 

 

Investors beware, what goes up must come down! 

I remember since I was a little kid there was a saying: the higher you climb, the further the fall. I believe this applies to almost everything, including the Magnificent Seven stocks. The S&P 500 this year has increased in value by $6.2 trillion, the Magnificent Seven having contributed $4.2 trillion. Throughout history, we have seen similar periods with stocks that have dominated the market going all the way back to the 1920s when it was the railroads. Then about 20 years later, it was chemical companies and automobiles. If you lookback 40 years, who could forget the AT&T monopoly and their break up in 1984. Over history, markets have gotten it right when it comes to the benefit of technology, but the highflyers in the beginning generally do not do as well as time progresses. I believe many investors could lose buying the high flyers at these prices. Don’t forget about the Tortoise and the Hare.

 

Financial Planning: What is the Goal of a Roth Conversion?

A Roth Conversion is the process of transferring funds from a tax-deferred retirement account to a Roth account. When the funds are transferred, the amount is reportable as income and taxed during the year it occurs. However, once the funds are in the Roth, they can continue to be invested and grow tax-free without any required distributions in retirement. Unlike contributions, there is no limit on the amount you may convert. The transaction itself is relatively simple, you’re just moving money from one account to another. The difficult part is determining when, how much, and how often you perform these conversions. Many people and advisors mistakenly think the goal of Roth Conversions is to reduce your lifetime tax bill, which is not the case. The goal, along with most retirement planning strategies, should be to increase your after-tax retirement income; reducing taxes is simply a byproduct of that. Reducing taxes and increasing after-tax income may seem like the same thing, but they are not. What matters when performing a Roth Conversion is the marginal tax rate at the time of the conversion and the tax rate in retirement if that conversion is not performed. This marginal tax rate includes all taxes such as federal, state, net investment income, capital gain, and IMRAA. If you can convert funds at a lower tax rate than they would otherwise be subject to if not converted, you will increase your level of after-tax income in retirement, which accomplishes the primary goal. If your goal was simply to reduce lifetime taxes, that may cause you to convert too aggressively by converting too much and pushing yourself into a higher tax bracket. If you live long enough this may reduce your total taxes, but if you paid too much tax upfront on the conversion, you may not have enough after-tax Roth funds to create the level of income you need. In many cases it is more appropriate to perform several smaller, more calculated conversions. You probably won’t convert 100% of your pre-tax funds, you may still have some extra Medicare premiums to pay, you may eventually get pushed into a higher tax bracket, but that may be necessary if the net result gives you the highest level of income after paying those.

 

Companies Discussed: Carnival Corporation (CCL), Levi Strauss (LEVI) and International Paper (IP)

July 6, 2024 | Largest US Banks, Jobs Report, Labor Market, Risky Investing and Reviewing Mid-Year Income

Largest US Banks 

I continue to remain optimistic about investing in the large financials, specifically the money center banks. For the most part they trade at good valuations and the recent stress test shows they remain healthy. All 31 of the largest US banks passed the Federal Reserve’s annual stress test, which provided a hypothetical scenario where unemployment levels rose to 10%, commercial real estate values decreased by 40% and housing prices fell by 36%. Following the results, the banks released plans to buyback stock and increase dividends. JPMorgan increased its dividend 8.7% and authorized a new $30 B share repurchase program. Jamie Dimon noted the dividend increase marked the second this year for JPM. Citigroup raised its dividend 5.7% and said it would continue to assess share repurchases. Bank of America increased its dividend 8%, but made no mention of share repurchases. Wells Fargo increased its dividend 14% and said it has the capacity to buy back common stock over the four-quarter period starting Q3 2024 through Q2 2025. You likely won’t see these stocks double over the next 12 months, but I believe many of them over the next few years could produce sound returns of around 10% when including dividends.

 

Jobs Report

The labor market continues to soften, which should be a positive for Fed rate cuts. Nonfarm payrolls increased by 206,000 in the month of June, which was better than the 200,000 estimate but less than the downwardly revised gain of 218,000 in the month of May. Combined, nonfarm payrolls in April and May were reduced by 111,000. Looking under the hood, the report was even weaker than the headline number indicated considering government was the second largest contributor adding 70K jobs in the month. Health care and social assistance continued to lead the way as the sectors added 82.4K jobs and construction was strong as well as it added 27K jobs. Areas of weakness included manufacturing (-8K), retail trade (-8.5k), and professional and business services (-17K). Wage gains also continued to soften as average hourly earnings were up 3.9% year over year. This was below last month’s reading of 4.1% and is well below the high in 2022 of 5.9%. The unemployment rate climbed to 4.1%, which tied the highest level since October 2021. Part of the increase in the unemployment rate came from a 0.1 percentage point increase in the labor force participation rate to 62.6%. The so-called prime age rate, which focuses on those between ages 25 and 54, rose to 83.7%, its highest in more than 22 years. While a lot of this report may sound negative, it is important to remember that the labor market is softening from a very strong level. We also need to see the labor market soften to give the Fed more confidence in their ability to cut interest rates. I would say this report was very positive considering it achieved the goal of softening without being damaging. We should keep an eye on the reports moving forward to make sure the labor market doesn’t fall off a cliff, but as of right now I don’t see that happening. 

 

Labor Market

In the recent JOLTs report, job openings showed the labor market continues to soften but to a healthy level. Openings stood at 8.1 million in the month of May, which was an increase from 7.9 million in April. While openings have fallen from a record of around 12 million in 2022, they are still above prepandemic levels when they were tracking at just under 7 million. The report showed the number of job openings for each employed worker remained at 1.2. This is below the peak of 2.0 in 2022, but it is right around prepandemic levels. I would not be surprised if we continue to see the labor market soften even a little further. I believe this would be healthy for the economy as it would create a more balanced labor market between employers and employees.

 

Risky Investing

I’m very concerned that the bar on risk taking in investing continues to rise. We are already dealing with craziness like GameStop, Roaring Kitty, cryptocurrencies with no real value, and technology companies that have expectations that the earnings will continue to go to the moon. Now add to that list what is known as “zero days to expiration” better known as 0DTE options. These options currently account for nearly half of the daily volume of the S&P 500 index options, more than double the 17% in 2020. These are simply one day options on the S&P 500 and the NASDAQ 100. It is estimated by early 2025 these 0DTE’s will be available for individual equities as well. That’s unbelievable! There will be sometime in the future that an event will cause wide volatility and many of these gamblers will lose large amounts of money. I’m disappointed that this is being allowed and the SEC and other regulators are letting this happen. I can’t believe I’m going to put this in print, but maybe I should send this to Elizabeth Warren. I’m afraid unsuspecting people with money will see on social media some people shouting how they made tens of thousands of dollars one day with small investments. What you won’t see is the larger majority of investors losing large sums through this gambling tool. In fact, retail investors lost more than $350,000 on 0DTE options on an average trading day between May 2022 and September 2023. You also won’t see the fact that institutional traders with their algorithmic trading and market makers are able to pounce on split second moves, leaving retail investors with the losing crumbs. I’m in hopes sometime down the road we will see these smaller brokerage firms that are pushing the 0DTE’s hit with large fines and hopefully forced into bankruptcy. However, in the meantime, these brokerage firms will be bringing in millions and maybe billions of dollars in fees and commissions. There are more portions of the market now that is no longer investing, but more like playing the lottery or gambling and betting on short term movements. In my opinion 0DTE’s should be illegal and people gambling like this should lose their money as it is high risk gambling. What concerns me is they will relate it to the stock market and when they lose money they will say the stock market is risky. If you invest in good quality equities and have a time horizon of 3 to 5 years and they have strong fundamentals, stocks are not risky. Unfortunately, many people right now are caught up in the hype and are more into gambling rather than investing.

 

Financial Planning: Reviewing Mid-Year Income

Now that we are half way through the year, it can be helpful to review your income to estimate how you will end up by the end of the year and make some adjustments. Maybe you had some unexpected income like extra capital gains or a bonus or perhaps your business had more sales than you were expecting. These increases in income may push you into a higher tax bracket or trigger income-related surcharges like the net investment income tax or IRMAA. More income is better than less, but if this is the case, now is the time to mitigate the tax hit. If you are still working, it may be helpful to increase retirement contributions or change which accounts you are contributing to. If you are retired, you might want to adjust how much you are withdrawing from accounts or adjust which accounts you are withdrawing from. It may also be necessary to adjust your withholdings or make an estimated tax payment if you have not withheld enough so far to prevent extra penalties and interest for underpayment of taxes. With rising rates, the interest for underpayment of taxes is much higher than in years past. Other tax strategies like Roth conversions are better implement at the end of the year, but making mid-year adjustments can help your annual income end up where it needs to be.

 

Stocks Discussed: Micron (MU), Whirlpool (WHR), Nike (NKE)