January 27, 2024 | GDP Report, PCE, Interest Rates, Federal Reserve Balance Sheets and Rule Changes for Inherited IRAs

GDP Report

I would say the GDP report was an extremely strong indicator that the economy is progressing in the right direction. While the growth number in Q4 of 3.3% was impressive compared to the estimate for a 2% gain, I believe the inflation numbers were even more important. The PCE price index increased just 1.7% in the fourth quarter and when looking at the “core” PCE, which excludes food and energy it increased just 2.0%. I believe this points to the possibility that barring any major shocks, inflation should continue to decline towards the Fed’s 2% target on an annual basis as we progress through this year. When looking at the growth in the GDP, it was interesting to see that all components produced positive benefits for the report. With growth of 3.8% in goods spending and 2.4% in services spending, overall consumer spending grew 2.8% and added 1.91% to the headline number. Private investment also grew 2.1% and added 0.38% to the headline number. Within private investment I was happy to see a mild impact from the change in private inventories as it added just 0.07% after a large impact in Q3 when it added 1.27% to GDP. Trade added 0.43% to the headline number as exports grew an impressive 6.3%. Lastly, government spending rose 3.3% which added 0.56% to the headline GDP number. Overall, I believe this report puts the economy in a great spot as we progress through 2024 as the potential for the soft landing is looking more and more realistic.

 

PCE

More good news on the inflation front as the Personal Consumption Expenditures Price Index (PCE) showed an annual increase of just 2.6% in the month of December. More importantly, core PCE, which removes food and energy and is the Fed’s primary gauge, showed an annual increase of just 2.9%. This was a decline from 3.2% in the month of November and was the lowest 12-month rate since March 2021. This gives me even more confidence that we could come very close to the Fed’s 2% target by the end of the year and that my estimation for 3-4 rate hikes remains in likely. I believe as we exit the year the talk around inflation and the Fed will no longer be as newsworthy as investors move on from the inflation concerns.

 

Interest Rates
At Wilsey Asset Management, we do expect to see the Federal Reserve to begin reducing interest rates with 3 to 4 cuts starting around the middle of the year. I have heard some estimates as high as six, but I think those are too aggressive. At our firm, we are value investors and we think this will be a positive as the cost of capital could decline for the equities that we hold in the portfolio, which would lead to a nice investment return. If you’re a growth investor, you may not experience the same type of return on your equities. I based this on when the Federal Reserve reduced interest rates in 2001 it did not help growth stocks go up in price and they actually underperformed. So as always be careful on the expensive growth stocks, they don’t always perform as you may hope.

 

Federal Reserve Balance Sheets

The mainstream media loves to talk about all the negative news they can find, but never seem to want to talk about positive news. I remember the Federal Reserve’s balance sheet assets rising to nearly $9 trillion when they were at their high. They have been quietly reducing the assets on their balance sheet and as of early January they had fallen to $7.74 trillion. When compared to January 2023, that is a decline of nearly $850 billion. I do believe at the current pace and with the current economy by January 2025 perhaps we could see the assets on the Federal Reserve’s balance sheet under $7 trillion. The Fed is currently allowing $60bn of maturing Treasuries and $35bn of agency mortgage-backed securities to run off its balance sheet each month. For reference, before the pandemic the Fed’s balance sheet stood around $4 trillion.

 

Financial Planning: Rule Changes for Inherited IRAs

The SECURE ACT passed in 2019 but one of the major provisions has not been enforced until now. Beginning in 2020, beneficiaries who inherit a retirement account can no longer stretch distributions out over their life expectancy and instead must deplete the account within 10 years. For accounts with pre-tax funds like traditional IRAs, this can result in a large amount of additional taxable income. This has been the case since 2020, but now in situations where the original account owner was old enough to be taking Required Minimum Distributions, meaning they were in their 70’s or older when they died which will be most people, the inheriting beneficiary now must also take a required distribution each year starting in 2024 in addition to depleting the account in 10 years. This beneficiary RMD has not been enforced in 2020-2023 due to the lack of clarity surrounding this rule, but the grace period is now over. There’s a bunch of people out there who have inherited retirement accounts in the last 4 years and haven’t done anything with them, however if they don’t take their distributions going forward, they will be subject to a 25% penalty. So, people with inherited IRAs need to make sure they take that distribution this year and be prepared for the tax impact of it. Keep in mind this applies to non-spouse beneficiaries who inherited accounts in 2020 or later. For accounts inherited before 2020, beneficiaries will see no change and may continue stretching distributions. Also, spousal beneficiaries may still treat retirement accounts as their own and are not subject to any special distribution rules.