Smart Investing is the radio show where Brent and Chase try to make investing easier to understand. They demonstrate long-term investment strategies to help you find good value investments.
Episodes
Monday Mar 11, 2024
Monday Mar 11, 2024
Labor Market
While the headline number of 275k jobs created easily topped the estimate of 198k and sparked concerns the labor market remained too hot, the details of the report showed a much softer labor market. To begin, the prior two months saw a downward revision of 167k jobs, which more than offsets the beat we saw in the month of February. Also, while I generally am a little more skeptical of the household survey, it did show a decline of 184k in those that were counted as employed, which led to an uptick in the unemployment rate to 3.9%. This was above the estimate of 3.7%. I was also disappointed to see that government remained a large contributor in the establishment survey as the sector added 52k jobs. Outside of government, other areas that were strong included health care & social assistance (+90.7k), leisure & hospitality (+58k), and construction (+23k). Wage gains were also a bright spot in the report as average hourly earnings increased 4.3% compared to last year. This was below the estimate of 4.4% and below last month’s reading of 4.5%. I believe this report continues to put us on track for 3-4 rate cuts in the back part of the year.
JOLTs Report
The January Job Openings and Labor Turnover Survey (JOLTs) was right in line with expectations and the previous month as job openings totaled about 8.9 million. This remains well below the high of 12.2 million in March 2022, but is still well above historical norms as prepandemic we had not seen a reading above 8 million. I continue to believe job openings will continue to trend lower to come back in line with historic levels. This does not mean we believe we are seeing a weak labor market, but I would call it a normalizing labor market. We have also seen a normalization in quits which should be a positive for wage pressure. Quits in the month were 3.4 million. This compares to annual quits of 44.4 million or 3.7 million per month in 2023. Total quits in 2023 fell by 6.1 million when compared to 2022. Looking at prepandemic levels, quits totaled 42.1 million in 2019 which would have been an average of 3.5 million. Layoffs were also strong in the month as they totaled just 1.6 million. This is right in line with 2023 levels as for the full year they totaled 19.8 million and averaged 1.65 million per month. In 2019, layoffs totaled 21.7 million and averaged 1.8 million per month. I wanted to provide all this data to show the labor market may be softening from strong levels, but I believe there is still some room to have numbers normalize without tilting us into a weak labor market.
China
What happened to China? The country had such a robust economy just a few short years ago, but the writing was on the wall. Here are the problems that caused the economic downfall. A real estate boom which accounted for 25% of China’s annual economic output. The debt and inventory continued to rise in houses and condos but many remained empty with no one able to buy them. The government cutoff the debt to developers, which ended the real estate boom. Consumers who did buy into the expensive housing market in China leveraged beyond their means with the expectation that the growth would continue and they could sell out with a profit. Unfortunately, they are now sitting under water in much of their real estate, but still have to pay the debt and don’t have much discretionary income to spend in other parts of the economy. China is now experiencing deflation, which will give them negative growth in parts of their economy for perhaps years to come. China’s overall debts have now surpassed 300% of GDP with very little chance of the economy growing to pay down that debt. Many years ago, they put a cap on how many babies people could have and now that is hurting them with an aging workforce and a shrinking workforce. It will take years to reverse this. In the meantime, the economy remains underwater. Since 1998 foreign investment in China has always been on the upswing, but that run came to an end in the third quarter of 2023 as foreign companies sold out and left or just stopped investing in China. There is nothing left to build in China when looking at their infrastructure. They have built many roads, railroads and airports so there’ll be no future investment in infrastructure. China has always been a communist country and I don’t think they really understood capitalism very well. An economy will always go through the ups and downs, but the United States has been around for 200 years and we have learned some valuable lessons like 1929 and 2008. While we can’t avoid the down turns, we have learned how to minimize the depths of the down turns.
Personal Consumption Expenditures
The Personal Consumption Expenditures Price Index, known as the PCE and is the main inflation gauge that the Federal Reserve looks at came in with a good inflation number. Excluding food and energy the change from one year ago for January was 2.8%, which shows a nice downward trend from December 2023 of 2.9%, November 2023 at 3.2%, and then October 2023 at 3.4%. The numbers are going in the right direction, but they are now falling a little more slowly than the big jumps we had. I still believe by the end of the year we should be at 2%, which is the Fed’s target and they should start reducing rates by midyear. Even though they won’t be at their target of 2% by June or July they need to start reducing rates a little bit to prevent a recession in 2025. At Wilsey Asset Management, we do believe the Federal Reserve came to the rescue to reduce inflation a little bit late but have now done a good job on managing the economy. We continue to believe that the Federal Reserve will do a good job in 2024, but stay tuned as we will be on top of it each month as the data is released.
Social Security Changes Coming?
The State of the Union was this week and one of President Biden’s talking points was Social Security. He stated, “Working people who built this country pay more into Social Security than millionaires and billionaires do” so he vowed to “make the wealthy pay their fair share”. It is true that millionaires and billionaires whose incomes do not come in the form of wages or self-employment do not pay into Social Security, but they are also not entitled to Social Security benefits in retirement. Working class people do in fact pay more into Social Security, but they are also the only ones who receive it. However, for people who do pay into Social Security, benefits are subsidized by high-wage earners and business owners for the benefit of low-income earners. As an employee, 6.2% of wages are withheld for Social Security up to a cap of $168,600. The Social Security benefit amount is based on 35 years of earnings which is used to determine the average monthly earnings. The full retirement amount will be the sum of 90% of the first $1,174 of average monthly earnings, 32% of the next $5,904, and 15% of any monthly earnings above that. For example someone who made $50,000 per year would receive $2,014 per month at their full retirement age which is 48% of their earnings. For someone who made $150,000 per year, their Social Security would be $3,759 per month which is 30% of their earnings. Even though both paid the same 6.2% of their income into Social Security, the lower-earner received a much larger percentage of their income in the form of benefits. In the case of business owners, they have to pay double the tax for a total of 12.4% because they are considered both an employee and employer, and they have to pay 6.2% for all their employees. So a business owner is really paying more into Social Security than all their employees combined. In regards to making the wealthy pay their fair share, there have been proposed bills that would tax earnings over $250,000, over $400,000, or possibly tax investment income. However, it is unclear if these additional taxes would change the potential benefit amount of those paying them, or if they would just benefit lower wage earners. There is no doubt that the Social Security system needs some adjustments, but we must understand the facts before implementing change.
Monday Mar 04, 2024
Monday Mar 04, 2024
401k Loans
It was nice to see that retirement assets saw a nice increase in 2023. According to Fidelity, the average 401k was up 14% from a year earlier to $118,600 and the average IRA was up 12% to $116,600. While it is good to see this progress, balances are still short of the year end 2021 levels when the average 401k reached $136k and the average IRA stood at $131k. I was somewhat surprised but happy to see the average 401k contribution rate, including employer and employee now stands at 13.9%. With the decline in companies offering pensions, employees really need to make sure they are saving at least 10% of their pay to achieve an enjoyable retirement. On the other side of the equation, I was disappointed to see the percentage of workers who took a loan from their 401k, including for hardship reasons, increased to 8.9% from 7.8% at the end of 2022. Many times, people believe 401k loans are great option, but it costs you greatly when you consider the loss of compounding and the tax inefficiency. They are better than mounting high interest credit card debt, but they should only be used as a last resort rather than a tool to fund a vacation or buy a new toy.
Hype Investing
At Wilsey Asset Management we avoid hype investing. From time to time, we attempt to give evidence of how long-term, hype investing can destroy your portfolio. Here’s another example, in 2021, you may recall the hype around electric vehicles, people made it sound as if an internal combustion engine vehicles would never be sold again and we would all be driving electric vehicles. Well, the hype of the stock price matched that excitement, two examples are Lucid and Rivian automotive. The all-time high a couple years ago for Lucid was $35, recently it has fallen to under three dollars a share, a 91% decline. The other example is Rivian, in late 2021, it hit an all-time high of $146 per share and has recently fallen under $11 a share, a 92.5% decline. It is possible for these companies to turnaround and may do well in years to come, the massive decline in stock price is the reason we will not invest in a company which does not have earnings, and we will not pay more than 10 to maybe 12 times for those earnings going forward. We may miss out on some highfliers. but I’d rather take it slow and steady than try and hit the home run and lose 80 to 90% on an investment. For Lucid to get back to $35 a share that would be over a 1000% return.
US Farmland
Farmland in the United States has been on quite the ride for the past 26 years. Back in 1997, the average price per acre for farmland in the US was $1,270. It has now increased by over 430% to $5,500 per acre. Now before you people in San Diego think that is not that good because of the appreciation you’ve seen on your house, remember this is nationwide and a 400% plus return is very good on real estate. The question is, will it continue? Over the last 20 years, farm acreage has declined by about 50,000,000 acres to just under 900,000,000 acres nationwide. Development has been taking away some of the agricultural land which could drive prices higher. That could encourage farmers to take advantage of their high value real estate and retire. That would not be a good thing for our agricultural needs going forward.
Is Long-Term Care Insurance Worth it?
Most people know that elder care can be expensive later in life which begs the question, “Is long-term care insurance a viable solution?”. The long-term care insurance industry has evolved a lot over the last four decades. In the 80’s, 90’s and early 2000’s there were policies available that were affordable and provided more coverage, such as lifetime benefits. However, over time the insurance companies came to realize they weren’t making money because more people were filing claims than expected. As a result, most insurance companies have stopped selling this type of insurance all together, and the ones that remain have substantially reduced benefits and increased premiums on new and existing policyholders. Therefore, the cost/benefit ratio for long-term care insurance is not nearly as attractive as it once was and retirees are typically better off exploring other ways to pay for elder care.
Monday Feb 26, 2024
Monday Feb 26, 2024
Commercial Real Estate
We hear that commercial real estate properties are having problems, but how bad are those problems? After the 2008/2009 financial crisis, by the second quarter of 2010 commercial property had a record $194.8 billion properties in distress. Compare that to the end of 2023, when commercial properties in distress totaled $86 billion. Also, think about how much commercial real estate has appreciated since 2010. Another point to consider, after the financial crisis there were not many funds on the sidelines and today real estate private equity firms are sitting on $544 billion in cash, which is a record level up from $457 billion in cash at the end of 2022. With that much cash, they will be interested in doing some deals and give a floor to many commercial properties across the country.
Should You Buy Nvidia Now?
We all know that Nvidia has done very well, and after the most recent report the stock is at a new high. I heard the dumbest thing from a money manager on CNBC, who didn’t own Nvidia and said you need to buy one percent of the stock in your portfolio. The reason I say it is dumb is because even if the stock doubles from here that would only increase your investment return by one percent. In other words, if your return was 10% over the next year, with the addition of Nvidia your return would be 11% if the stock doubles from here. This also assumes that had you invested one percent somewhere else it would’ve made no return at all. When it comes to investing, discipline is very important and yes, we all want to invest in investments that will increase in value, but an investor must understand their objective and their discipline, stay the course, and realize that one will not always own all the hot stocks and should not chase returns.
Chinese Car Makers
A Chinese electric auto maker, BYD, is sending chills across the auto makers in the US. Elon Musk said “If there are not trade barriers established, they will pretty much demolish most other car companies in the world. “In a memo from executives at Toyota, they stated Chinese companies have a 25 to 30% advantage over global competitors when manufacturing EVs. If not protected against, Chinese EV companies could storm the US market. In 2018, the Trump administration applied an additional 25% tariff on Chinese cars on top of the regular 2.5% tariff on all cars coming to the US. To get around this, BYD is looking at building a factory right across the border in Mexico. They have not purchased any land yet and this is a few years down the road, but it could be devastating to all car makers 3 to 5 years from now. I looked to see what the BYD cars look like and some of them are not that bad looking. Whoever becomes president in November 2024, I hope they look seriously at this situation to prevent BYD or any other Chinese carmaker from flooding our car market.
Financial Planning: Investment Return of Annuities
An annuity is exchanging your assets for income, you’re essentially buying a pension. It’s funny that pensions have such a positive connotation but annuities aren’t as popular, even though they’re pretty much the same thing. We don’t sell annuities and we don’t ever recommend annuities because when you look at the numbers, they aren’t that appealing for an investor. To illustrate this, I got a quote for a 65-year-old purchasing a $500k immediate annuity. In exchange for the $500k, they will receive monthly income of $3,000 for the rest of their life, which is a 7.2% yield. Keep in mind, the $500k is now gone, so they can’t decide down the road to do something else with their money. Statistically someone who is 65 has a life expectancy of about 83, or more 18 years. With this information we can calculate the expected return of the $500k investment and it comes out to 2.88% per year. In other words, if you were to invest $500k and then withdraw $3,000 per month for the next 18 years, you would need that $500k to return 2.88% per year to last the full 18 years. From an investment standpoint, most people wouldn’t be happy with an annualized return of less than 3% over almost 2 decades, but that’s what people agree to when they purchase an annuity. Don’t get confused by the 7.2% yield, which is misleading since those payments stop when you die. Instead, calculate the actual return to see if it still seems like a good idea. Keep in mind, the insurance company and the agent selling the annuity will not break down the actual return for you.
Tuesday Feb 20, 2024
Tuesday Feb 20, 2024
AI Outlook So Far
Microsoft spent about $7 million per 30 second ad for the Super Bowl promoting their Copilot AI service. Some results are not coming in so good for Copilot with some testers after using the software for more than six months said it was useful but doesn’t live up to its price. Another survey adopter said the initial excitement wears off with a 20% drop in use after only a month. Executives at Microsoft expected billions of dollars in new revenue as their search engine Bing would take market share from Google. Unfortunately, nearly a year later Bing has only seen less than a one percent gain in market share. A survey from Boston consulting group said that roughly 90% of business executives said generative AI is a priority for the company this year; however, 66% said it would take a couple years for the technology to move beyond the hype. 70% of those executives said they were only going to do small investments with limited testing. I’ve been concerned about the over hype of the money going into AI and the return on investment taking years to payoff. This would not be the first time on Wall Street that the hype sent stocks into orbit, only to come back down to earth when reality set in.
Investing in Technology
More strange news with the markets. As of the week ending February 9th, the NASDAQ was up 6.5% this year and the S&P 500, which is also heavily weighted in tech companies had increased 5.4% in 2024. This compares to a return of just 0.84% for the broader Russell 2000 index. The S&P 500 has increased 14 of the last 15 weeks something we have not seen since the end of 1972. I’m not saying the market is going to crash tomorrow, but the 73/74 market period had a very long bear market. The difference here is that our market is so concentrated in technology that I think we could see a bear market, but many companies will still gain going forward because of the great value that has been ignored. Another example of exuberance in technology would be that fact that since the 2008 financial crisis, US companies with dividends above 5% gave investors a return of 450%. Over that same timeframe, companies that don’t pay a dividend have returned nearly 1200%. Going back to the 1870s, this flies in the face of normal behavior. The excitement in tech has led to some major gains for the big tech companies and Microsoft is now the most valuable company with a market cap around $3.1 trillion. It is almost twice the $1.6 trillion value of the entire S&P 500 energy sector, yet it’s annual free cash flow of around $67 billion is less than half the $135 billion from these energy companies. I do not know what will cause a drop or when it will happen, I just believe many investors do not realize the risk that they are taking by investing heavily into technology. Unfortunately, all parties do come to an end.
CPI
The Consumer Price Index (CPI) caused a lot of concern and sent stocks lower as the reading came in above expectations. Frankly, looking through the data I don’t think the numbers were that bad. CPI rose 3.1% compared to last year which was above expectations of 2.9%, but was lower than the reading of 3.4% in December. Core CPI, which excludes food and energy rose 3.9% and came in above the expectation of 3.7%. This reading matched December’s 3.9% rise which was the smallest increase since May 2021. It is important to remember that numbers don’t always go in a straight line and I believe this report should not have a major impact on the Fed’s rate decisions. Especially, when looking deeper at the numbers. The shelter index again continued to be a heavyweight on the report as it climbed 6% compared to last year. This increase accounted for over two thirds of the 12-month increase in core CPI. It was also interesting that there was a little bit of a divergence between the rent of a primary residence which was up 0.4% in the month compared to the owners’ equivalent rent of residences which was up 0.6% in the month. I believe this is a silly metric that distorts the CPI level. The Owners’ equivalent rent is obtained through surveys and asks members of a household: “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished, and without utilities?" I don’t believe this is a great way for tracking shelter inflation and that these numbers should be taken with a grain of salt. Other areas of the report continued to see positive deceleration or even deflation in some cases. The energy index was down 4.6% compared to last year with gasoline falling 6.4%. Food at home showed a gain of just 1.2%, which compares to a peak of 13.5% in August 2022. Food away from home did have a larger increase of 5.1%, which likely stems from higher wages and the elevated demand we are seeing at restaurants and bars. Overall, as I said I don’t think this was a bad report, but investors need to realize that the Fed will not be cutting rates 6 times this year.
PPI
I was somewhat disappointed by the Producer Price Index (PPI), as I thought we would see better numbers. In January, PPI rose 0.3% compared to the prior month, which was the biggest move since August and it was well above the expected increase of 0.1%. Core PPI was even more troubling considering it saw a 0.5% increase, which easily topped the expectation for an increase of just 0.1%. Looking at the year over year increase, the numbers are less concerning. Headline PPI increased just 0.9%, but core PPI did see an increase of 2.6%. I wouldn’t recommend panicking over one report, but I will definitely be keeping an eye on inflation over the next few months. I still believe the broader trend will show a decline towards the 2% target, but there will likely be bumps in the road.
Financial Planning: Health Insurance Before Medicare
Most become eligible for Medicare at age 65. With Medicare you will have a Part B premium, which is $174.70 per month in 2024, and potentially an additional premium of up to $200 per month depending if you select a Medicare Advantage Plan or a Medicare Supplement Plan. If you retire before age 65, health insurance can be much more expensive and range into the thousands of dollars per month. For many this is a major factor in why they delay retirement. However, with the correct planning ahead of time, it is possible to retire early without being subject to exorbitant insurance premiums. When purchasing health insurance through the Health Insurance Marketplace, the actual premium is based on your income. This means if you can keep your income lower, you will qualify for the same coverage, but at a lower monthly cost. Some ways to keep income low is to keep extra cash, taxable brokerage accounts, and Roth accounts available as withdrawals from these accounts are not considered income. Therefore, these types of assets can cover livings expenses until reaching Medicare at age 65 while also keeping health insurance premiums, federal taxes, and state taxes at a minimum. This also means it may be necessary to defer other types of income such as Social Security, pensions, capital gains, pre-tax retirement account withdrawals, and Roth conversions until reaching age 65. There are many insurance plans available all with their own premium based on income, so it is important to choose the right plan to cover your individual medical needs, but with the right planning, there are affordable options available for early retirement.
Monday Feb 12, 2024
Monday Feb 12, 2024
CPI
One of the main reasons I continue to believe the Consumer Price Index (CPI) will continue to decelerate this year is I don’t believe there will be as much pressure from the shelter index. In December, the median U.S. asking rent price fell 0.8% from the prior year to $1,964. According to Redfin, this marked the third consecutive monthly decline as prices dropped 2.1% in November and 0.3% in October. The rent price reflects new leases which means I believe this will have a larger impact as we progress through 2024. I believe there will be even less concern over rent increases going forward considering the number of new buildings in the U.S. with five units or more. Looking at the chart below you can see that the amount of completed buildings is near the highest level in over 30 years and the number of new buildings under construction is at levels we have not seen before.
China Owning U.S. Debt
I have heard people worry about China owning U.S. treasury debt. Over the last decade or so, it truly has become a very small concern. China now holds just $782 billion of our debt which trails Japan at $1.1 trillion. China still tops the UK, but the gap has been narrowing over the years as the UK now holds $716 billion of US debt. The next largest foreign holders of our debt are Luxembourg at $371 billion and Canada at $321 billion. With our debt now over $34 trillion, China owns just over 2%. Compare this back to 2013 when Beijing’s holdings peaked at just over $1.3 trillion and our debt stood at close to $17 trillion and you will see the concerns over China controlling our debt are currently overblown. Back then they owned over 7% of our debt. The main benefit here is China no longer could threaten dumping our debt and causing a major spike in interest rates. The downside is our debt has continued to grow and with less demand for our debt from China, interest rates are likely higher than they would be if China was actively participating in buying more of our debt. Remember like everything else these markets are based on supply and demand. If there is more demand for our debt, prices would go higher and since there is an inverse correlation, interest rates would go lower.
Growth Companies
I don’t like to invest in the expensive growth companies because of the risk that comes with them. People often forget how much value they can lose and how long the recovery can be. One great example of this is Microsoft during the Tech Boom. In 1999, Microsoft could do no wrong and they were one of the most exciting companies in the world. The stock hit a peak of a split-adjusted value of $59.96 per share in December of 1999. The stock then fell dramatically during the tech bust and financial crisis and bottomed out in March 2009 at a price of $15.15 per share. This resulted in a decline of about 75% over essentially a 10-year period. The shares would not reach the 1999 peak until October 2016, essentially 17 years after it reached the tech boom peak. While the stock has done well as of late, how many people are patient enough to hold through a 17-year period with no growth? Not to mention if you need income from your portfolio, that would have been a complete disaster. While tech is hot again, I still recommend people be careful as they often forget the lessons from the past.
Financial Planning: Understanding Your Tax Phases
Sometimes it feels like taxes only go up, but it doesn’t have to be that way. In fact, most people go through different tax phases during their lives. While you’re working, taxes seem high because you’re subject to 5 different taxes. You are taxed federally, on the state side, and you have Social Security, Medicare, and disability taxes withheld from payroll. Then when you retire, things change. You’re no longer subject payroll taxes, which in California is a flat tax of 8.75%, and some of your retirement income may be partially or fully tax-free. For many this is a period of low taxation which means you don’t need as much total income to produce your after-tax cash flow. Then in your 70’s, you may see your taxes increase again due to required distributions from retirement accounts and extra premiums for Medicare. By understanding these different tax phases over time, you can take advantage of your tax situation and create a plan to save taxes over your lifetime.
Monday Feb 05, 2024
Monday Feb 05, 2024
Employment Situation
The numbers for nonfarm payrolls blew away expectations as they expanded by 353,000 in the month of January. This easily topped the estimate for 185,000. Job growth was widespread as it grew in every major category except for mining and logging which saw a decline of 6k in the month. Two areas that remained extremely strong were health care and social assistance (+100.4k) and professional and business services (+74k). Other areas of strength included retail trade (+45.2k), government (+36k), and manufacturing (+23k). The previous two months also saw upward revisions with an upward revision of 117k in December and 9k in November. There was some concern that maybe this report was too strong and that it could impact the Fed’s rate cut path. The major concern on the inflation front came from average hourly wages which jumped 4.5% and easily exceeded the forecast of 4.1%. While this could have an impact on inflation, it is important to remember that data doesn’t always move in a straight line. Also, the average hours worked fell to 34.1 which was 0.2 hours lower than the previous month and would have an impact on total labor cost. I was also happy to see in a separate report that the Employment Cost Index increase by just 0.9%, which was the smallest quarterly gain since the second quarter of 2021. Looking at year-on-year, labor costs increased 4.2% in Q4 which marked the smallest rise since Q4 of 2021. Overall, I think this report shouldn’t throw a wrench in the idea of the Fed cutting rates in the back half of the year.
Job Openings
It is looking like the economy could navigate a pretty remarkable feat with decelerating inflation rates, growth in the economy (albeit limited), and a resilient labor market. In the month of December, job openings rose to 9.0 million which easily topped the estimate of 8.7 million and marked a three-month high. This is well off the high of around 12 million that was achieved in 2022, but it still is a healthy level considering pre pandemic job openings were around 7 million.
Investment Grade Debt
I was surprised to learn that the amount of investment grade debt was $168 billion so far in the month of January. One would think that these corporations would do everything they could to hold off until the second half of the year when rates should be lower. Investors would have to go back 34 years to find this much debt issued in January. It makes one wonder do they know something we don’t know and maybe rates won’t be falling? I still remain very confident we will see rates fall in the second half of the year.
Liquid Cash
As of the third quarter of 2023, cash in money markets and CDs has reached an all-time high of $8.8 trillion. The last peak for CDs and money markets was reached in 2008 when it climbed above $6 trillion. At US lenders, total deposits fell to $17.4 trillion from the peak of $18.2 trillion, but when you combine the two you have around $26 trillion of liquid money. The question is, as rates fall where will this money go and how much will be transferred to longer term investments like real estate and equities? I don’t believe we will see much action here until probably the last quarter of 2024 and even more likely happening in 2025. However, as an investor, I would rather be investing early than late because that will hurt your long-term returns. I think investing in the right equities on sale over the next six months will provide good returns when you look at December 31st, 2025.
Financial Planning: Tax Filing Review
With tax season coming up, it is helpful to review your tax return before filing to catch any mistakes. Some of the most common errors include misreporting 1099-Rs, missing rental expenses, incorrectly reporting capital gains, and missing IRA contributions. Any time money leaves a retirement account a 1099-R is generated, even with Roth accounts. However just because a 1099-R is generated, does not mean the distribution is taxable. Roth withdrawals and more commonly rollovers to other retirement accounts are not taxable. We have seen cases where a non-taxable distribution is reported as income due to the receipt of a 1099-R, so if you had retirement account distributions in 2023, make sure you’re only paying for taxable withdrawals. With rental properties it is common to have insurance, property taxes, interest, HOA or management fees, and depreciation all listed as expenses. If any of these are missing or seem low after reviewing the Schedule E, it may be necessary to go back and recount all your rental expenses to confirm you are receiving all possible deductions. When selling assets like a business or property there is no 1099 generated, so it is helpful to double check how a taxable sale is reported on the Schedule D. We’ve seen sales reported as a short-term gain instead of a long-term gain which can result in substantially more taxes. Lastly if you made any contributions to pre-tax retirement accounts like an IRA or SEP, be sure these contributions are reported and deductible. When making a contribution to an IRA, a Form 5498 is generated, but this form isn’t available until after taxes are due. This means you have to remember to report the contribution because there will be no tax form showing it. There’s many possible errors or omissions when filing a tax return, but these are some of the more common ones to keep an eye out for.
Monday Jan 29, 2024
Monday Jan 29, 2024
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.
Monday Jan 22, 2024
Monday Jan 22, 2024
Banks and the Economy
Each quarter we get very excited to see what the major banks have to say about the consumer and the economy. Last Friday, JPMorgan, Wells Fargo, Bank of America and Citigroup all reported earnings. The overall comments were the consumer is still strong. The CEO of Wells Fargo said average deposit balances per customer remain above 2019 levels and loans to businesses were up in the quarter. There were some write-offs on commercial office buildings with Bank of America charging off the most at $100 million. In total the four banks charged off $6.6 billion of all loans which was double what it was one year ago. Profits for the four banks in the fourth quarter were up 11% from one year ago coming in at $104 billion. JP Morgan Chase accounted for roughly half of that profit with $50 billion in the quarter. These profits are pretty amazing because in addition to the $6.6 billion charge off for loans, they also had to set aside $9 billion to pay a special Federal Deposit Insurance Corporation (FDIC) fee which was related to the failures of Silicon Valley Bank and Signature Bank. So, I’m happy with the report and do continue to believe 2024 will be a good year for the economy and the consumer, but as always, we will receive our bumps and bruises as the year progresses.
Office Space
It was reported that 19.6% of office space in major US cities was sitting empty in the fourth quarter of 2023. That is the highest number on record which goes back to 1979. The problem is twofold. First, there are still some people working exclusively from home, which I still say as time passes more people will be coming into the office as businesses need to increase their profits and productivity. Second, overbuilding occurred for years with commercial buildings. It was noted that the bulk of the vacant space in buildings were built from the 1950s through the 1980s. If you’re going to get an employee to come back to the office, they don’t want to go back to some rundown building. They are asking for beautiful buildings with coffee bars, gyms, and Pickleball courts. There are some good opportunities for investments in class A commercial buildings that are in booming areas, but investors have to be wary that they are not investing in lower grade class B or C buildings in run down cities.
Consumer Spending
I think someone forgot to tell consumers to slow down on spending. Retail sales were strong in December as they grew 0.6% for the month, which topped the estimate of 0.4%. Looking compared to last year, December sales were up an impressive 5.6%. Areas of strength included food services and drinking places (+11.1%), non-store retailers (+9.7%), and electronics and appliance stores (+10.7%). Areas that weighed on the report included gas stations (-6.6%), furniture and home furnishing stores (-4.7%), and building material & garden equipment & supplies dealers (-2.3%). While this is good news and shows the consumer is still strong, it is leading to concern around the Fed’s rate cut path. I’m still optimistic the Fed can balance the economy and rate cuts to navigate a soft landing.
Financial Planning: Taxes When Selling a Home
A house is considered a capital asset, and when a capital asset is sold for a profit, a capital gain is produced which can result in a tax bill. For homes that have been the primary residence of the seller for at least two years out of the last 5 years, a home sale exclusion applies which reduces the amount of capital gain by up to $500k for a married couple or $250k for a single person. For example, if a home was purchased for $250k then sold years later for $1,250,000, there would be a capital gain of $1,000,000. This gain may then be reduced by the $500k exclusion, resulting in a taxable capital gain on the remaining $500k. If the home was instead sold for $700k after purchasing for $250k, the gain would only be $450k, which the exclusion would completely cover resulting in no taxes on the sale. If there is a taxable capital gain after the exclusion, it will be taxable at the lower capital gain rate as opposed to ordinary income rates on the federal side. On the state side the gain will be taxed as ordinary income as most states don’t have separate capital gain tax brackets. For married couples with an adjusted gross income of about $125k or less, including any taxable gains from a home sale, the federal capital gain tax rate is 0%. So, if a residence is going to be sold, it would be best to sell during a year with low income such as the first year of retirement so that the 0% tax bracket would absorb some of the gain. Once income goes above $125k, the next capital gain bracket is 15% up to an income level of about $615k at which point the tax rate increases to 20%. It is also important to keep a record of any home improvements or selling costs as these can be deducted against the taxable gain. Due to appreciation in the housing market, it is getting more common for home sales to result in taxes, so be diligent about keeping records and be careful when you sell a home so you don’t pay more taxes than necessary.
Monday Jan 15, 2024
Monday Jan 15, 2024
Inflation Numbers
While the headline inflation numbers were above estimates, I wouldn’t say there were really any surprises in the Consumer Price Index (CPI) report. Headline CPI rose 3.4% vs the estimate of 3.2% and core CPI rose 3.9% vs the estimate of 3.8%. Although it was slightly higher than anticipated, progress is still being made on the inflation fight and core CPI registered its lowest reading since May 2021. As it has been the case for many months, the shelter index was the major contributor as the annual increase of 6.2% accounted for about two-thirds of the rise in inflation. Other areas that remained problematic included motor vehicle insurance (+20.3%), admission to sporting events (+14.9%), and motor vehicle repair (+10.3%). One area I found interesting was food, the entire index increased just 2.7% from last year but the divide between at home and away from home has widened substantially. The at home index showed an increase of just 1.3% compared to the away from home index which grew 5.2%. I believe this divide will remain due to the demand for dining out and the wage pressure restaurants and bars are facing. Overall, I don’t think this report moves the needle one way or another for the Fed and I believe rate cuts will start in the back half of the year.
PPI
More good news on the inflation front, as the Producer Price Index (PPI) showed an increase of just 1.0% compared to last year. Core PPI, which excludes food and energy, was up just 2.5% compared to last year. This points to more good news ahead on the inflation front as the PPI is normally a leading indicator.
REITs
With what I believe was the last rate hike of the cycle in the books, one area to evaluate is real estate. I’m not talking about single family homes or private investments, but rather looking at public Real Estate Investment Trusts (REITs). These trade on the stock exchange, but instead of owning a business you will own the real estate that is bought within the trust. I believe there are many great values in the public real estate market at this time when analyzing the cash flows that an investor receives and historically REITs have outperformed the S&P 500 index by approximately 4.5 percentage points in the 12 months following the last interest-rate hike in a cycle. Looking at the last three hiking cycles, REITs have had an average total return of 19% in the 12 months following the last hike in a cycle. I believe the right real estate in the portfolio is a great area to look for value as we look down the road 2-3 years, not to mention many of these REITs have great dividend yields.
Bitcoin ETF
The hype for the bitcoin ETF is at all-time highs, as the SEC has now approved them for investments. We still don’t understand why people would want to buy an ETF that holds just one product like bitcoin. But for those who do, the fees are out and Fidelity has disclosed they will charge .39% annually for holding bitcoin. Their ETF competitors Invesco and crypto firm galaxy will charge 0.59% for holding bitcoin. I’m sure you’ve heard of the Grayscale bitcoin trust which charged an annual fee of 2% on the assets, they have now reduced that fee to 1.5% since it is now an ETF. I still believe this is hype, where the rumor will be far better than the news. I would not be surprised that for 2024 bitcoin is currently trading around its highs for the year.
Financial Planning: Social Security Spousal Benefits
Social Security spousal benefits come into play when one spouse has little to no earnings history. In this case their own social security benefits would be low, so they can claim a spousal benefit from the spouse that did work. There’s a common misconception that it’s ½ of the higher earning spouse’s amount, but the actual calculation is ½ of the working spouse’s full retirement age amount and the non-working spouse would need to apply at their own full retirement age. The working spouse may apply at any point between age 62 and 70 and the spousal benefit is still ½ of their age 67 amount. The non-working spouse may collect as early as age 62, but they will receive a reduced benefit for every month they collect before age 67. Upon reaching age 67, they do not receive a larger benefit by waiting any longer. The only other caveat is the working spouse must be collecting social security for the non-working spouse to collect a spousal benefit. In situations where the higher earning spouse is not collecting social security because they are still working or they are waiting until age 70, this prevents the non-working spouse from collecting. If the non-working spouse has reached age 67, benefits are being permanently lost. This is compounded by the fact that the spousal benefits will only last until the death of either spouse because only the higher social security benefit is retained by a surviving spouse. This is one of several instances where it is better to collect Social Security sooner rather than later.
Wednesday Jan 10, 2024
Wednesday Jan 10, 2024
Jobs Report
There was initial concern that the jobs report was too strong and could point to inflationary concerns. After digging into the report, I believe it is still in line with our belief that the economy is in a good enough spot to have a soft landing and avoid further inflationary pressures. The initial concern stemmed from the fact that headline employment grew by 216,000 in the month of December, which easily topped the estimate of 170,000. While this may sound extremely strong, the previous two months were revised lower by a total of 71,000 jobs. Also, Government was a major contributor in the report as the sector added 52,000 jobs in the month of December. With such a large contribution from the public sector, this shows me the private sector is continuing to soften. Areas of the private sector that were strong included health care and social assistance (+58,900), leisure and hospitality (+40,000), and construction (+17,000). Even after many months of positive gains, the leisure and hospitality sector still remains 1% or 163,000 below pre-pandemic levels. Overall, the jobs market softened in 2023 as monthly gains averaged 225,000 for the year compared to 399,000 in 2022. I believe that those monthly gains will soften even further in 2024. The only concern I had about the report was wage inflation as average hourly earnings increased 4.1% compared to December 2022. This was above expectations for 3.9% and last month’s reading of 4%. Ideally, we would like to see this continue to soften as wage inflation generally pressures overall inflation, but data does always move in a straight line. It is something to keep an eye on, but I do believe wage inflation will also soften in 2024.
JOLTs
According to the Job Openings and Labor Turnover Survey (JOLTs), the labor market is continuing to soften. The report showed that job openings fell to 8.79 million in November. This was right in line with the estimate of 8.8 million, but it was lower than October’s upwardly revised report by 62,000 openings. If it stands, the report produced the lowest level of openings since March 2021. While this continues to sound negative, there are still 1.4 openings for every available worker. While this is lower than the 2 to 1 ratio, we saw for much of 2022, it is still well above historical levels and shows we have a good labor market that is softening from historic levels.
Dividends & Buybacks
Dividends and buybacks for 2023 came in with dividends holding strong at $588 billion which was an increase of 4.2% compared to 2022. Buybacks were still higher than dividends at $780 billion, but company executives in 2023 cut back 15.4% on stock buybacks for the year. Don’t think dividends at 2% or 3% are not worth putting your investment dollars into, going back 100 years dividends as a percent of the total return still account for 38%. For the long-term, investors should have equities in their portfolio that not only grow the stock price but also pay a dividend that the company increases overtime.
Federal Debt
In the first part of January, it was announced that the federal debt for the first time surpassed $34 trillion. Yes, a very large number, but it is important to understand the debt to GDP. Debt to GDP is like looking at your own personal situation where your income is rising and you can take on more debt to either buy a home, a car, or some other asset that you want to finance because you can afford the payments. The debt to GDP peaked at the end of 2020 touching 126% and the most recent data shows debt to GDP has now fallen to under 120% of GDP. If the economy can continue to grow faster than the increase in the debt, the percent of debt versus GDP will go down and put the country in a better financial position.
Financial Planning: Structuring Income for 2024
With the new year comes a fresh slate for your taxes, so now is the time to plan out your income for 2024. If you are withdrawing money from investment accounts, you’ll probably want to take another look at it as tax brackets and RMD’s have changed. Withdrawals from pre-tax accounts are considered ordinary income, Roth withdrawals are tax-free, and withdrawals from taxable accounts are tax-free. Taxable accounts contain capital gains and dividends which are taxable even if you don’t withdraw anything, but they are taxed at lower rates. Depending how you structure where your income comes from will determine how much you have to pay to the government. Ordinary income is taxed the highest, and it’s okay to have ordinary income as long as it only fills up the lower tax brackets. Tax-free income is obviously preferred, but you don’t need to only have tax-free income because then you’re missing out on the benefit of the lower tax brackets. Ideally you want to have the right amount coming from each source to satisfy your living expenses while keeping your income on paper at the most efficient thresholds. For those with lower expense needs, a threshold to plan around is an adjusted gross income of $30,000. At this level there would be no tax because the standard deduction would reduce taxable income down to nothing. $30,000 might seem low, but at that level social security is largely tax-free and if there is some Roth income, it is possible to have $5,000, $6,000, or even $7,000 of monthly cash flow while keeping that annual AGI at $30k. The next threshold is an income level of about $125,000. This is the point where ordinary income moves from the 12% tax bracket to the 22% tax bracket and where capital gain and dividend income moves from the 0% bracket to the 15% bracket. You really have to be careful here because a little extra ordinary income might fall in the 12% bracket but that can push some capital gain income up to 15% so your marginal rate temporarily is 27%. Next is an income level of about $210,000 for those 63 and older. This is when Medicare premiums start to increase based on higher income levels and since there is a 2-year gap between income and premiums, you need to be aware of this at 63 and not 65. Lastly for those with higher incomes, the threshold to watch out for is income of about $415,000 which is where the tax rate increases from 24% to 32%. No matter your income needs, it will help to plan it out because ultimately the goal is to be able to retire sooner with more income and pay less tax on that income.
Tuesday Jan 02, 2024
Tuesday Jan 02, 2024
Santa Claus Rally
If you felt disappointed in your gifts from Santa this year, there is still hope he brings your investments some nice returns. We are currently in the middle of the Santa Claus rally which is the period of time that includes the last five trading days of the current year and the first two trading days of the new year. Historically these seven days have had higher stock prices 79.2% of the time and since 1950 the average gain was about 1.4
Cryptocurrencies
Bitcoin and cryptocurrencies have been rising in 2023. We all know that criminals use cryptocurrencies for kidnapping, drugs and ransom. I was surprised to learn since 2017 hackers have used $2.7 billion for ransom payments. Over the last couple of years, it has approached a half billion dollars per year for crypto payments, perhaps helping push up the price of bitcoin. This has been a major problem considering the ease for the cyber gangs to transfer bitcoin and remain anonymous. Think about this, if you enjoy buying and trading bitcoin, you’re helping the gangs that do these ransom attacks make money off their illegal activities that are crushing companies such as Clorox, MGM Resorts, Caesars entertainment, and even the U.S. Marshals Service just to name a few. And guess who’s paying, yes you the consumer. I have hated cryptocurrencies since their invention because I said they have no real use. I guess unfortunately I was wrong, the criminals seem to love cryptocurrencies. Other than that, they really have no other use and I do believe one day they will be worthless. In the meantime, people continue to help out criminals by buying and holding cryptocurrencies.
Banks
We have had some good returns on our banks in our portfolio this year as some banks have returned over 20%. This is in-spite of the fact that a couple times this year we were in the negative column for returns on these big banks. We believed that since the fundamentals were very strong these banks were worth holding onto. Now with 2023 coming to a close, the big question is what to do in 2024 as interest rates decline as this could be a problem for the big banks. A mistake that small investors make is to not understand the full business of the bank. While loans produce big profits for banks there are other ways a bank can profit than just loans. If rates decline as we think they will, that could accelerate banks operations on the equity side, with more companies paying them to do initial public offerings. Another thing that people probably have no idea about is as rates become lower the banks unrealized paper loss on the bank security portfolio will boost the value of fixed rate securities that they bought when rates were much lower. If this paper loss drops back down, that can help a bank with capital levels and the banks could be open to bigger stock buybacks in 2024. So if you have the right banks in your portfolio at the end of 2023, it looks like next year could be another winner for the big banks. As always at Wilsey Asset Management, we will continue to do our Monday numbers on these companies, along with digging through the quarterly conference calls and financial statements. If things were to change, we could end up selling out of the big banks.
Magnificent Seven
I’m looking for a good return in the right stocks next year. I believe the market will broaden out considering much of the gain this year came from the Magnificent Seven (Apple, Microsoft, Amazon, Alphabet, Meta, Tesla, & Nvidia). One reason I am optimistic is there is still a lot of money held in money-market funds that I believe will be redeployed next year as the rates on cash become less attractive. Total assets held in money-market funds is near record levels at about $6.1 trillion. This is about 29% higher than just before Covid. The pros may even have excess cash to deploy next year. According to a Bank of America survey, the average portfolio manager holds about 4.5% in cash which is down from a multidecade peak of over 6% last year but still substantially higher than the lows of just over 3%. With interest rates likely to fall next year cash will be less attractive which should be a major benefit to stocks.
Monday Dec 18, 2023
Monday Dec 18, 2023
CPI
The Consumer Price Index (CPI) did not show us much new news and I believe it will be enough for the Fed to keep rates steady and put an end to their hiking cycle. The headline number showed just a 3.1% increase compared to last year and the core CPI, which excludes food and energy showed an increase of 4%. The headline number saw a nice benefit from falling energy prices as the energy index declined 5.4% compared to last year and gasoline prices were down 8.9% compared to last year. Although the annual increases showed little to no change compared to last month, it’s important to understand the progress that has been made from the peak inflation levels. In June 2022, headline CPI hit a cycle high of 9% and in September 2022, core CPI hit it’s cycle high of 6.6%. Progress continues to be made in many areas including food at home which showed an increase of just 1.7% compared to last year, but remains stubbornly high in areas like motor vehicle insurance which was up 19.2% compared to last year and motor vehicle repair which was up 12.7% compared to last year. Shelter continues to be the big headwind in the report as the index was up 6.5% compared to last year and accounted for nearly 70% of the total annual increase in the core CPI. While this has taken longer than I anticipated, I still believe this shelter index will see subsiding price increases which should continue to bode well for the overall inflation report.
Government Debt
Many times I’m asked or hear concerns by people about the government debt and I tell them I don’t like where it is, but it’s not a major problem at this point. Currently the debt to GDP stands at 119.47%. Compare that to another developed nation like Japan, who has a debt to GDP of 263%. I do not wish to see the US get into that situation, but you have to notice that Japan has not fallen and it has continued to move forward. One problem with our government debt being so high is that there is only a certain number of buyers looking for debt and if the government is absorbing more debt to cover their bills, it takes money out of the private sector debt market, which can slow down our economy. In summary, we are not in danger territory, but to improve our growth going forward we need to get a handle on our debt and or grow our GDP much more. I still believe there is no need to panic for years to come.
Apple
In the future, the next iPhone you purchase may not come from China and instead it may come from India. Within two to three years, Apple is expecting to build over 50 million iPhones in India. If Apple reaches this goal, that would mean India would make up about 25% of global iPhone production. Currently global iPhone shipments are around 220 million per year, which means China will still continue to account for over 50% of the iPhone production. It does appear that relationships with Apple and the Chinese government are a little strained since the Chinese government banned some officials from using iPhones at work. Apple responded saying any iPhones sold in China will be produced in China. There are unions in India that do put up some barriers for Apple, but so far, they have been able to work with the unions to get things done like having the ability to do a 12-hour workday if production increases are needed. Even with Apple’s popularity here in the US, Samsung is still the global smartphone leader.
Accident Repair
People who own EV’s may be saving money on gas, but they lose that benefit when it comes to repairs if you get in an accident. This is because of such things as how the cars are built and special storage may be required because of lithium batteries to prevent fires. Last year the average cost for a crash of an electric vehicle was $6,587 which was 55% higher than on all vehicles which was $4,215. You may be thinking that’s ok, I don’t have to pay for accidents as my insurance will cover them. Unfortunately, the insurance companies know they pay more for electric vehicle repairs so you’ll pay 44% more for car insurance on an electric vehicle or about $357 per month compared to $248 per month for normal vehicles. You may still love your electric vehicle, but they’ve only really been around for a few years. As time passes, we are finding out more about some downsides that we did not know before.
Financial Planning: The Season of Giving
Whether it’s to charity, church, or family, people tend to be in a more giving spirit during the holidays. If you happen to be in the giving mood, there are a few stipulations to be aware of. When giving to family or friends, there is an annual gift limit that applies. In 2023 it is $17,000 per person and next year it increases to $18,000. This limit is stackable so a married couple may gift $34,000 to as many people as they want and may repeat this for as many years as they want. This gift is not deductible to the giver and does not count as income to the recipient. For extra generous givers, a 529 account may be used to gift 5 years’ worth of gifts at a single time, meaning a married couple could give $170,000 to as many beneficiaries as they want. This applies to beneficiaries of any age and they do not need to use the funds for education as long as they withdraw the entire gift from the 529 before it has a chance to accumulate earnings. Givers may also gift appreciated shares of stock to avoid paying taxes on the gains. In this case, the recipient inherits the gain and will realize income if the shares are sold, which may be at a lower tax rate than the giver. When making charitable gifts, it is important to verify if the donation will be deductible to you. In order to receive a tax benefit, you must itemize your deductions which means you need the total amount of your deductions to exceed the standard deduction. This applies to both federal and state taxes so even if you do not itemize federally, you may still itemize on the state side and receive a tax benefit. Givers may also donate appreciated shares of stock when donating to charity to receive the tax deduction and avoid the capital gains tax. If you liked the investment, you could repurchase the stock which essentially resets your cost basis while you receive the tax benefit from the donation. Keep in mind, when you give to charity, the dollar amount of the tax benefit does not outweigh the amount of the donation so it is still costing you money. In other words, you are still being charitable! Lastly, for people who are over the age of 70.5, have an IRA, and who would like to make a charitable donation, they should heavily consider using the IRA to make the donation directly to the charity. This is called a Qualified Charitable Distribution (QCD) and will offer the same tax benefit as an outright donation, but with a bunch of extra perks. With a QCD, the giver receives the full tax benefit whether they itemize or claim the standard deduction. Since the donation is coming from an IRA, this will reduce the amount of future required distributions and therefore reduces taxable income. Also, a QCD is not included in either the adjusted gross income or taxable income (regular donations only reduce taxable income) which means the donation may also reduce Medicare premiums in addition to taxes. If you plan to give this season, doing it in the most efficient way will give some tax savings or even allow you to give more.
Monday Dec 11, 2023
Monday Dec 11, 2023
Employment
While the headline numbers for the jobs report showed results that beat expectations, when you look closely at the report it shows a softening labor market which is exactly what the Fed wants to see. Nonfarm payrolls in the month of November showed a gain of 199,000 which topped the estimate of 190,000 and the unemployment rate fell to 3.7% which was better than the forecast for 3.9%. The growth of 199,000 is below the average monthly gain of 240,000 and it is also important to point out that some of the gain in November was attributed to the end of the UAW and actors strikes. In fact, while employment in manufacturing increased 28,000 in November there was a 30,000 person increase in motor vehicles and parts as workers returned from strike. The employment in information also had a gain of 10,000 in the month, but motion picture and sound recording industries added 17,000 jobs as the resolution of labor disputes came to an end in the industry. The strikes have created volatility in the numbers over the last few months and that can also be seen in the revision to September where total nonfarm payroll employment was revised lower by 35,000. With these major strikes now behind us, we should be able to see a better reading in these job numbers moving forward. Another major area the Fed likely has their eye on is the change in average hourly earnings, which points to wage inflation. In the month of November average hourly earnings increased by 4.0%, which was the lowest reading since May 2021. Overall, this report points to the concept that a soft landing is still a real possibility. I believe the labor market will continue to soften, which should be good news for inflation and our economy.
JOLTs Report
While it may not look like good news when reading the headline number, the JOLTs report showed exactly what the Fed is looking for. Job openings of 8.73 million in the month of October were below the estimate of 9.4 million and showed a decline of 617,000 or 6.6% compared to the previous month. This also marked the lowest number since March 2021. While this all sounds troubling, it shows the labor market is softening which is what the Fed has wanted to see. It also shows that the labor market is still doing alright considering there are still 1.3 job openings to every available worker. Pre-pandemic this ratio stood at 1.2.
Drug Companies
The Biden administration has opened the door to seize the patents of certain costly medications from drugmakers. The administration has unveiled framework that outlines the factors federal agencies should consider in deciding whether to use march-in rights, which take patents for drugs and shares them with other pharmaceutical companies if the public cannot reasonably access the medications. Officials can now factor in the price of a medication in deciding to break a patent. While this may sound like a nice practice, I do worry about the long-term ramifications. While drug companies often do have nice margins on drugs that succeed, people generally do not discuss the billions of dollars that is spent on research and development for drugs that do not succeed. If drug companies cannot offset those costs with high margins on successful drugs, the industry could have major problems. Also, what would the incentive be to spend billions of dollars on research and development for a new drug, when you could just potentially wait for another company to come up with the solution and then use their patent that has been taken from them by the government? This could ultimately stifle innovation in the industry.
Magnificent Seven
Remember a few years ago the FANG stocks? They have now been replaced by what is known as the Magnificent Seven which are Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta. People still believe index investing is a great way to invest and diversify your portfolio, but when you look at the S&P 500 you should realize that the Magnificent Seven have carried the index to a year-to-date return of around 20%. If you look at that equal weight index it is actually only up around 6% this year. Also, in the index 44% of stocks are showing negative results. You may think you had diversification with the S&P 500 but currently the seven stocks account for close to 30% of the index. These companies stock prices have continued to perform, but history has proven time and time again that any equity trading at such high valuations eventually comes back to reality. When that happens investors in these seven stocks, and also the index will have disappointing returns. Unfortunately, I cannot tell you when it will happen, only that history has proven itself to be right 100% of the time.
Financial Planning: Reviewing Income at the End of the Year
As we get closer to the end of the year, it is getting more important to review income levels and make any necessary adjustments before December 31st. When analyzing income, it is helpful to identify the expected level of adjusted gross income (AGI), the number of itemized deductions (if any), the amount of total taxable income, and the amount of taxable income subject to ordinary income rates. Adjusted gross income is the sum of all reportable income which could be wages, capital gains, interest, IRA distributions, and Social Security to name a few. After tallying AGI, next is the itemized deductions which include mortgage interest, state income and property taxes, charitable donations, and medical expenses. Taxpayers can claim the larger of the itemized deductions or the standard deduction which is $27,700 for a married couple in 2023. These deductions act as an expense which reduces the adjusted gross income and results in taxable income (AGI – deduction = taxable income). From there the long-term capital gain and qualified dividend portion of income can be separated from the other ordinary taxable income as capital gains and dividends are taxed at a lower rate (taxable income = ordinary + capital gains and dividends). From this point a taxpayer can determine what tax bracket they will be in, the tax rate of their capital gains and dividends, and whether their income will trigger any additional net investment income tax or Medicare premiums. Finally, action can be taken such as Roth conversions, realizing gains or losses, charitable donations, or retirement contributions to push income in a more efficient direction.
Monday Dec 04, 2023
Monday Dec 04, 2023
Annual Home Sales
The higher interest rates have put a damper on home sales, which is no surprise. The seasonally adjusted annual sales came in at 3.8 million for October. Not only is that a decline of 4.1% from September, it is the lowest seasonally adjusted annual home sales since August 2010 which was over 13 years ago. As interest rates pull back somewhat going forward, we could see some better homes sales but I do not believe we’ll see any type of boom that will cause home prices to increase substantially.
Delinquencies
You may be hearing about the increase in delinquencies for Americans, but at the end of September just 3% of outstanding debt was in some stage of delinquency. What you won’t hear is back in 2009 delinquency rates hit a record 12% and going back to a more normal economy in 2019, delinquency rates were 4.7%. Here is another fact for you that shows things are not as bad as the media wants you to believe. As a whole, consumers used an average of only 24.1% of their credit card allowance which is still below 2019 when it was 24.6% of the outstanding allowance.
Core PCE
The Fed’s preferred measure known as core PCE rose just 3.5% year over year in the month of October, which was down from 3.7% in September and marked the lowest reading since April 2021. Core PCE excludes food and energy from the headline number. If we look at headline PCE, it was even more impressive due to lower energy prices as it rose just 3% compared to last year, which was down from 3.4% in September. This report is further evidence that inflation is continuing to decelerate and reinforces my belief that the Fed’s interest rate hiking cycle has ended.
Real Estate Market
Just how strange is the current real estate market? Pending home sales, which looks at signed contracts in the month of October dropped 8.5% compared to last year and registered the lowest reading since the National Association of Realtors began tracking them in 2001. This means that home sales are worse now than the Great Recession in 2008/2009. The main issues in the month were high interest rates, which shot above 8% in the month and the limited amount of supply. Given the wild swing in interest rates, I still believe it will take a few years for the real estate market to normalize.
Monday Nov 20, 2023
Monday Nov 20, 2023
PPI
More great news on the inflation front as the Producer Price Index (PPI) fell 0.5% in the month of October, which was well below expectations for a 0.1% increase. This also marked the largest monthly decline since April 2020. Compared to last year, the index showed an increase of just 1.3% which was a nice decline from September’s reading of 2.2%. Even looking at the core PPI, which excludes food and energy there was a positive news. It was flat compared to September which was below the expectation for a 0.3%. The reduced inflation problems for producers should continue to benefit consumer prices in the months ahead.
CPI Report
There were some major positives in the CPI report which sent interest rates tumbling. In fact, the 10-year treasury fell to below 4.5%. What was so positive about the CPI? The headline number showed just a 3.2% increase in inflation compared to last year and the core CPI showed a gain of just 4.0% which was below the expectation for a 4.1% increase. This was also the lowest reading for core CPI since September 2021 and it is well below the peak of 6.6% that was hit last September. Areas where inflation still remains hot include admission to sporting events (+25.1%), motor vehicle repair (+15.1%), and motor vehicle insurance (+19.2%). Another area that continues to push inflation higher is shelter which increased 6.7% compared to last year. I continue to believe this index does a poor job reflecting the current state of shelter costs, yet it accounted for more than 70% of the increase in core CPI. As the shelter index normalizes, I believe we can quickly see a push towards the Fed’s target of 2%. While I don’t believe we will get there next year, I do believe we will see core inflation fall below 3%. For this reason, I do believe the Fed’s hiking cycle has ended. I believe they will continue to talk tough and push the higher for longer narrative, but with cooling inflation next year I would not be surprised to see rate cuts in the back part of the year. This should bode well for the right stocks in the market.
ETF Investors
I was shocked to see that based on an annual study from Schwab Asset Management, millennial ETF investors have 45% of their portfolios in fixed income which is substantially higher than 37% for Generation X. Also, 51% of millennials plan to invest in bond ETFs next year, compared to just 40% of baby boomers. I believe the craziness of Covid investing and the meme stock craze has dented millennials view of stocks. Many want the quick hit when it comes to investing and they have failed to realize how long-term investing actually works. The unfortunate part is many of these millennials are hurting their long-term investment returns by shifting so much into fixed income and when they realize the benefits of long-term investing 5-10 years from now, they will have missed out on the massive benefit of compounding during that time period.
PEG Ratio
Every Monday we go over the main fundamentals of all the equities we hold in our portfolio. I’m talking about such things as the valuations for the earnings, sales and cash flow. We also look at the growth rate on the earnings and sales along with the debt and the liquidity of all the equities that we own. There are many other factors we look at and the entire process takes between three to four hours every Monday. We have done this every Monday for well over the past 20 years religiously. The reason I bring this up is I cannot remember the last time I saw such strong price/earnings ratios and attractive PEG ratios for companies in our portfolio. The PEG ratio shows an investor what they’re paying for the future growth of a company. PEG Stands for price/earnings divided by growth. No one knows exactly when the turnaround will happen, but based on our 40 years of experience in the finance world, we have been through this many times and we are confident companies/stocks will soon be based on valuations including the PEG ratio. Those investors that remain patient with the right companies as always will be rewarded. Investors who panic and fall in love with a CD at 5% will have regrets down the road.
Financial Planning: Tax Loss Harvesting
Tax loss harvesting is when you sell an investment for less than you purchased it for to create a realized loss that can be used to offset other capital gains. Investors like to engage in tax loss harvesting at the end of the year to reduce their tax liabilities. Before selling a position at a loss, it is import to understand the full tax benefit and the opportunity cost so you can decide if it is worth it. For example, let’s assume you wanted to take a loss on a $50,000 investment after the stock declined 15% to $42,500, resulting in a $7,500 loss to be used to offset some long-term capital gains. The average investor is in the 15% federal capital gain tax bracket and the 9.3% state tax bracket, meaning the $7,500 loss results in a tax reduction of $1,822.50. This sounds nice, but your $42,500 position would only need to grow by 4.29% to recoup that $1,822.50 tax savings, which is absolutely possible assuming the investment was purchased for the right reasons and still has strong fundamentals. Volatility in the market is normal, so it is important to avoid missing out on big gains to save a little in taxes. This doesn’t mean tax loss harvesting is always a bad thing, in fact, there can be several reasons where it makes a lot of sense. If an investor can offset short-term capital gains or ordinary income with tax loss selling, the extra tax savings due to the higher tax rate may justify realizing a loss. Also, if an investor’s AGI is close to triggering extra Income Related Monthly Adjustment Amounts for Medicare premiums or additional Net Investment Income Taxes, then a reduced income level from tax loss harvesting could be valuable. Or perhaps the investment doesn’t have a lot of potential so it would be best to sell and purchase something else while receiving some tax saving consolation. There are instances where tax loss selling is helpful, but realizing losses simply because you have some gains is not always the best decision.
Monday Nov 13, 2023
Monday Nov 13, 2023
PC Sales
We have seen global shipments of PCs decline to 245 million this year, a drop of nearly 100 million from 2021 when global shipments reached 342 million. You may think that PCs are going to go the way of the dinosaur, but that is not the case. Personal computer companies are preparing new PCs that will begin arriving within the next few months that have AI in them. I’m sure you’ve heard of the CPU, which is the central processing unit, a GPU which is a graphics processing unit and now there is a NPU, which is a neural processing unit. The NPU can process very large data sets efficiently and will pick up most of the AI computing requirements. Just recently, Intel unveiled an AI PC acceleration program which will use AI techniques on such things as content creation, security, audio effects and video collaboration. It is expensive and time consuming to run AI in the cloud which has 1.76 trillion parameters but a PC can be more focused just on certain areas as opposed to the entire universe of AI. Maybe in the next couple years we will see a big boom in PC sales.
Commercial Real Estate
I know many people are concerned about commercial real estate, but I believe there are some great opportunities given the extremely negative sentiment. The office sector has been of great concern, but when listening to the conference call for a public REIT we own in the portfolio I remain quite optimistic. The CEO pointed to many major positives including new tenant leasing marking the 11th consecutive quarter at or above pre-COVID levels. Leasing has been extremely strong this year and the company expects to see the highest amount of new tenant leasing since 2016. Retention rates also look good coming in at 70%. Don’t get me wrong there are some definite cracks in the sector, but be careful throwing the baby out with the bathwater. In fact, JLL recently reported that after analyzing its vast data set of office buildings, comprising over 2.7 billion rentable square feet across the top 25 MSAs (Metropolitan statistical area) 50% of the sector's vacancy is concentrated in the bottom 10% of the office stock. I believe the office still has a place in our economy but it is the strong Class A properties that will remain.
Growth Companies
People and investors always like the excitement of growth companies with high expectations that they will have great returns. This week the growth company WeWork filed for bankruptcy in New Jersey. This company has never seen a quarterly profit but yet the stock price did reach a high of $130.80, it currently trades for less than a dollar. The big problem with this growth company was excessive expansion which caused excessive losses and rising debt they could not pay. At our firm, Wilsey asset management, I still continue to believe as I have for many, many years we will not invest into or hold a company that has no earnings and high debt. I may have missed some huge gains on a few companies, but I do believe being cautious and not having losses from companies filing bankruptcy is a far better plan for a long-term return and also, I think it is much easier on the emotional side.
Financial Planning: 2024 Tax and Retirement Changes
As we get closer to the end of the year, more information is being released about 2024. Each year the IRS adjusts the tax brackets for inflation and in 2024 the increase will be 5.4%. This is a good thing as it allows slightly more of everyone’s taxable income to fall in lower brackets and results in a tax reduction. The standard deduction, which acts as a deductible expense for most taxpayers, is increasing for married couples from $27,700 to $29,200 plus an extra $3,100 if 65 or older. For single filers it is increasing from $13,850 to $14,600 plus $1,950 if over 65. Retirement account contributions are receiving an increase as well as the maximum contribution for employer plans like 401(k)s is increasing from $22,500 to $23,000, plus an extra $7,500 for savers older than 50. IRA contribution limits are increasing from $6,500 to $7,000 plus a $1,000 catch-up contribution for those older than 50. With these upcoming changes everyone should review their income and savings plans for 2024 to make any necessary adjustments.
Monday Nov 06, 2023
Monday Nov 06, 2023
Employment
While the employment numbers missed expectations, it is a big positive for interest rates as the labor market is slowing and should provide evidence for the Fed that their hiking cycle can end. The headline number showed nonfarm payrolls increased by just 150,000 in the month of October vs the expectation for an increase of 170,000. The prior two months were also revised lower by a total of 101,000 jobs. While this may sound like bad news the key takeaway here is the labor market is softening, but it is still doing ok. Areas of strength were health care and social assistance (+77,200), government (+51k), construction (+23,000), and leisure and hospitality (+19,000). While I generally don’t like to see government jobs leading the way in employment reports, hiring has lagged in the sector and has now finally returned to pre-covid levels. Manufacturing was a major loser in the month as 35,000 jobs were lost. While this may sound troubling, 33,000 of those lost jobs came from motor vehicles and parts which can be attributed to the UAW strike. With the resolution now in place with the auto manufacturers, we should see most of these jobs come back next month. Also, another positive on the inflation front was average hourly earnings which increased 0.2% in the month versus expectations for 0.3%. Compared to last year average hourly earnings were up 4.1%, which would mark the smallest year over year increase since June 2021.
Labor Market
Even with a softening labor market, there are still plenty of jobs out there. The Job Openings and Labor Turnover Survey (JOLTs) showed there were 9.55 million available positions in the month of September, which means the ratio of job openings to available workers still stands at an impressive 1.5 to 1. The number of layoffs in the month also headed lower and stood at just 1.5 million compared to 1.7 million in the month of August. As a reminder, before Covid in 2019 layoffs averaged over 1.8 million per month.
Federal Reserve Survey
A recent Federal Reserve survey said the average American is now worth $1 million, which is up 42% from $749,000 back in 2019. Now you may be thinking that includes multi-millionaires and billionaires, this is why the median wealth gives one a better idea of where America stands. From 2019 to 2022 median wealth hit $193,000 which is an increase of 37% adjusted for inflation. 16 million American families or a little over 12% now have wealth exceeding $1 million which is up from 9.8 million in 2019. These millionaires have received over 90% of their wealth from owning stocks, which is above the 87% home ownership rate. It was also discussed that for the most part they became wealthy over time and it did not happen quickly. A lesson for the younger generation, don’t be in a hurry to make big returns and lose your money. Be smart by investing in good quality equities and using taxpayer advantaged programs like IRAs and 401(k)s. Also, it is important to look where you will be in 30 years not 30 days.
Interest Rates
While I believe over the next couple years rates will decline from these levels, I’m not optimistic it will be a major decline. One reason for that is the elevated government deficit. It was announced the treasury will be auctioning off $776 B of debt in the final quarter of 2023 and $816 B in the first quarter of 2024. This comes as the government recently announced the fiscal 2023 budget deficit would be about $1.7 T, which is an increase of $320 B compared to the prior year. It is important to remember that the debt market is based on supply and demand. If there is not enough demand at lower interest rates, to absorb the remaining supply of bonds the interest rate would need to climb.
Financial Planning: Adjustable-Rate Mortgage Demand Spikes
It’s no secret that mortgage rates have climbed to their highest levels in over 2 decades. This has caused many potential home buyers to consider adjustable-rate mortgages as their initial interest rates can be significantly less. While 30-year fixed loan rates reach 8%, the rate for a 5/1 ARM loan hovers around 6.75%. These have a fixed rate for the first 5 years of the loan before becoming variable. Borrowers then have the idea of using an adjustable-rate mortgage to lock in the lower initial rate, simply to refinance before the fixed term ends, hopefully at a lower rate in the future. However, while the rate can look more attractive, these loans generally come high higher point costs. A point is an extra fee attached to a mortgage that is due at closing. Currently mortgage rates are priced based on the assumption that borrowers will look to refinance as soon as mortgage rates fall. Since ARMs have a lower initial rate and therefore less interest, extra point fees are added to make up for the fact they will likely be refinanced. Home buyers must look not only at the interest rate, but also the point cost, and how long they expect to have that loan before moving or refinancing. With mortgage rates at their current highs, it may make sense to accept a higher rate temporarily if the ultimate plan is to refinance in the next few years.
Monday Oct 30, 2023
Monday Oct 30, 2023
Investing Volatility
A recent client survey by Charles Schwab produced some viable insights during difficult times like this. Over the longer term 33% of investors attributed their greatest investing success to patience through volatility. It is hard to patient during the ups and downs, but the reality is when holding good quality investments, it has proven to always be the right thing to do. Unfortunately, patient doesn’t mean 2-3 months and sometimes it may mean 2-3 years. The funny thing is that even though that patience has always paid off, our emotions lead us to want to sell at the worst times and many people end up doing so costing themselves drastically in the long term. The second most cited reason for clients’ greatest investing success was careful research which came from 16% of respondents. We always tell people that before we step in and by a company, it’s at least 10-15 hours of research. This doesn’t mean you won’t have volatility, but it does give you more comfort in knowing and understanding your investments during the difficult times which allows you to be patient. The biggest culprit for an investors worst investment was lack of research with 20% saying this was the cause. This doesn’t surprise me as many people are quick to jump into the hype or invest in something because a friend or family member thought it was a good idea. Unfortunately, like the survey shows we have seen this work out poorly for many investors. Another big culprit for the worst investment was high risk with 13% of respondents citing this reason. In today’s society people want to try and make a quick return, but that is not how investing works. People want to try and get big returns and they end up losing massively. We tell our client’s a reasonable target should be around 8-12% in the longer term. Anything in excess of this and you are likely taking big risks that could put your portfolio in jeopardy.
PCE
There wasn’t much in the Personal Consumption Expenditures Price Index (PCE), which is the Fed’s preferred measure for inflation. The headline number was up 3.4% which was the same as last month. The core PCE, which excludes food and energy was up 3.7% and was one-tenth lower than the reading in August. Core PCE hit a peak around 5.6% in early 2022. With the aggressive increase in short term rates, the recent increase in the 10-year treasury, and the resumption of student loan payments likely slowing the economy somewhat I still believe the Fed should allow these hikes to sink in and evaluate where we stand in the coming months.
Recession
It is interesting how many people believed we were going to see a recession in 2023, but yet the numbers keep proving the doubters wrong. Today’s Q3 GDP report showed annualized growth of 4.9%, which topped the estimate of 4.7%. It’s important to point out that this report does account for inflation. The primary driver of growth here was the consumer as spending increased 4% in the quarter and accounted for 2.7 percentage points of the total GDP increase. Both goods and services saw nice increases as spending grew 4.8% and 3.6%, respectively. Gross private domestic investment also saw a major increase of 8.4% and accounted for 1.5 percentage points of the total GDP increase. Within this category the change in private inventories was the major contributor as it accounted for 1.3 percentage points of the headline number. Government spending and investment also grew 4.6% and accounted for 0.8 percentage points of the headline number. The only detractor in the report was trade as the net exports of goods and services took away 0.08 percentage points from the headline number. While I believe this will likely be the highest GDP report we see for some time, I do believe we can still avoid a recession as the consumer remains in a good spot.
Financial Planning: Annuity Sales Continue to Grow
As market volatility continues, annuity sales continue to climb. Last quarter annuity sales hit $89.4 billion which is an 11% increase over the 3rd quarter of 2022, according to LIMRA. Sales reached a record in 2022 and that record may be beat in 2023. This is common during times of uncertainty in the market as investors and retirees look for safer places to put their money and many advisors are happy to sell them. This can feel more comfortable in the short term, but typically leads to underperformance in the long term. Retirees must remember that inflation and longevity risk, in addition to market risk, need to be factored into their retirement income plan. Annuities reduce portfolio volatility and can provide peace of mind at the expense of performance. Even in retirement, assets need to grow to outpace inflation and provide income, and lower performance increases the risk of running out of money too soon.
Monday Oct 16, 2023
Monday Oct 16, 2023
CPI
I was somewhat disappointed by the Consumer Price Index (CPI) as I believed there would be a slower growth in the inflation rate. With that being said, I don’t believe the report is problematic. The headline number for September of 3.7% matched August’s rate and was only slightly ahead of the expectation of 3.6%. The core rate which excludes food and energy came in at 4.1% which
was right in line with expectations and was below August’s reading of 4.3%. This was also the lowest reading on core CPI since September 2021 when the report showed inflation of 4%. Regarding the miss on the headline number, it is important to remember that with the recent increase in energy prices we have lost a major benefit that was pushing the headline number lower for most of this year. In fact, energy prices only fell 0.5% compared to last year and gasoline prices were actually up 3%. This compares to just a few months ago in the month of June when energy prices were down 16.7% and gasoline prices were down 26.5% compared to the prior year. These declines were extremely helpful for the headline number CPI number. One area that remains surprisingly high is the shelter index as it climbed 7.2% compared to last year. I have pointed at many times that this is a lagging indicator, but I am surprised to see how much it is still weighing on the overall inflation front as housing/rent prices have cooled tremendously on a real time basis. With that said, the shelter index accounted for over 70% of the total increase the core CPI. I still believe the shelter index is likely to cool as we end the year which would be very beneficial to both headline and core CPI.
Stock Market Volatility
You may be wondering why there is so much volatility in the markets lately and I will tell you it’s because of too much information. I’ve been managing money for over 40 years and remember back when Alan Greenspan was the Federal Reserve chairman and he was the only member of the Fed who would speak. He also did not speak very often. He spoke so little that financial commentators on TV would make decisions based on the size of his briefcase on what decisions he may make. The FOMC consists of seven members of the Board of Governors and then there are 12 Regional Federal Reserve Bank Presidents. It seems to me that many more of these Governors and Federal Reserve Bank Presidents are
speaking publicly on their thoughts. I do agree that we need information but not the opinions of so many different people who can change their mind when they meet and make decisions on interest rates and policies. I know it will not change, but I think too many people giving their views on what they think will happen is doing nothing more than causing volatility and confusing the investor. In the end it doesn’t matter what they say it is only important what they decide when they meet eight times a year. Everything else is just a bunch of confusing noise.
Treasury Yields
Many investors have been concerned by the move higher in treasury yields, but I believe it has been more a move towards normalization. Sure, rates have climbed rapidly, but if you go all the way back to 1790 the average yield for U.S. government debt is 4.5%. We are slightly above there now and may drift a little higher considering history shows that the fed-funds rate and the 10-year Treasury have tended to peak around the same level. This means we may breach the 5% threshold, but I do believe we would not see rates climb much from there and would mean we are near the top. Over the next few years, I believe we could see rates around the 4% level. Investors need to be realistic and understand the days of one or even two percent rates are in the past and extremely unlikely to occur anytime soon. Higher rates don’t always necessarily mean stocks can’t perform well and in fact from the mid-1980s to 2008, real rates were more than a point higher than now, and stocks returned 15% a year.
Monday Oct 09, 2023
Monday Oct 09, 2023
Jobs Report
The September jobs report was released on Friday, October 6 and at first glance it was scary because it was so good. But then as the day moved on the report was analyzed further and positive information was found. What was scary about the report was 336,000 jobs created, twice as much as expected. This caused concern that there would be a definite increase in interest rates in November by the Fed. Also giving more concern was the July and August numbers were revised higher 119,000. But as the day progressed and the numbers were analyzed, it was understood that average hourly earnings had only increased 0.2% below the expected 0.3%. This is also the mildest we have seen over the last 18 months. The federal reserve has been concerned about wage growth, and this report is proof there should be no concern on wage growth. The strength in the job market was seen in leisure and hospitality, healthcare, professional, scientific, and technical services. What this report is revealing is that we can increase people working but yet wages are not getting out of hand which is something the federal reserve was concerned about. The consumer price index which is the gauge on inflation will be released next Thursday, October 12 and based on what we are seeing here at Wilsey Asset Management we believe it will be a good report and if that holds true, we could be done with anymore rate increases for the rest of 2023 which raises the green flag to invest in the right equities.
JOLTs Report
The JOLTs report showed Job openings rose by nearly 700,000 in the month of August to 9.61 million. This easily topped the estimate of 8.8 million and means there are still about 1.5 jobs available for each unemployed worker. Layoffs also remained low at just 1.7 million. While this is positive for the labor market, concerns remain that a tight labor market could pressure the Fed to continue tightening policy. I believe there are other factors on the inflation front that should lead to a stabilization from the Fed rather than a continued increase. The positive news continued to push treasuries higher, and the 10-year treasury pushed passed 4.75% to reach its highest level since 2007.
Oil Prices
We have seen a dramatic rise in gas at the pump which has been caused by the rising price of oil. Just a couple of months ago at the beginning of July oil was at $71 per barrel, it has increased substantially and ended September at $91 per barrel. Yes, that is a 28.2% increase. At the end of September, we also saw US commercial crude inventories at their lowest level since December 2022. Before you jump to conclusions and think gas prices are going to continue to rise, let me give you some fundamentals behind the scenes. Because of the rising prices gasoline consumption is declining and if prices were to hit $100 per barrel that would cause a further decrease in consumption. It is a world market and China has built up over the last three years a very large inventory of oil which they acquired at low prices. This means they likely will not be coming back into the market, since they have more than adequate supplies. Also, if oil were to hit $100 per barrel that could bring more inventory online increasing the supply and also it is possible that Saudi Arabia would bring back some of their production that they took off line earlier this year. Keep in mind an unexpected supply shock would cause oil prices to continue to rise, barring that scenario I believe we should be close to the top!
Investment Returns
Last week in a newsletter we said that we see a very good fourth quarter for investors as it could produce some good fourth quarter investment returns. The personal consumption expenditures price index (PCE) was released and came out at 0.4% last month. Core prices which exclude food and energy only rose 0.1% which is the weakest monthly increase since 2020. If you look at June through August of this year core prices only increased at 2.2% on an annualized basis, which is very close to the Fed’s 2% target. Based on this data, I believe the Federal Reserve once again will pause at the meeting on October 31st. I’m seeing no indication of rising inflation overall, even with the increase in prices at the pump I believe there will be another positive PCE Report released about a month from now and then no increase in interest rates once again in December. If you agree with this data, you should not be sitting on much cash or short-term instruments that pay 4-5%. You should be investing that money in good quality equities or else you’ll be scratching your head in January on what you missed.
Financial Planning: Social Security: A Solution to Insolvency?
It is well known that the Social Security trust fund is running out of money. It is projected that the program will be insolvent in about 10 years at which point beneficiaries would only receive 80% of their expected benefits. While we think it unlikely this will come to fruition, there will absolutely be changes to the program over the next decade. Most proposals to fix this problem involve an increase to taxes or a decrease in benefits in some capacity as the Social Security trust fund by law can only invest in US treasuries and cannot borrow. Over the last few years, US Senators Bill Cassidy and Angus King, who sit on opposite sides of the isle, have been working on an alternative solution. The idea is the federal government would borrow $1.5 trillion over 5 years for an “unrelated” third party to invest for the next 75 years. In the meantime, the Social Security insolvency would be financed with additional government borrowing. After 75 years, the accumulated investment principal would repay the $1.5 trillion plus any additional borrowing and accumulated interest and the balance would go to the Social Security trust fund. Over any 75-year period the US stock market has always far outpaced the return of US treasuries so in theory this would solve the issue without tax increases or benefit cuts, but this borrow-to-invest strategy, known as a pension obligation bond, is frowned upon for government agencies. Between the borrowing and investing, not to mention government corruption, there’s a lot that can go wrong here, and failure in a program as large as Social Security would be catastrophic for American taxpayers.