Understanding Your 1099s

Tax season is frustrating for lots of people. Our system is incredibly complicated and, perhaps ironically, only gets more so when we’re doing what we’re supposed to be doing like working hard, saving, investing, and so forth. Still, we have to tally everything up once a year and pay our share to keep the lights on, or so they tell us.

According to a 2021 survey by the IRS more than half of American taxpayers use a paid preparer to file their returns. Most people I know have a “tax person” and this also seems true for most of my clients. Personally, I did my family’s taxes for years using TurboTax but shifted to using a CPA about ten years ago when I started this business. Coordinating business and personal tax, and doing it well and accurately, is hard and I’m happy to pay a professional to do it for me.

Other surveys indicate that maybe 60% of people would prefer to do their own taxes with good software and a simpler system, so there’s DIY interest out there. Various websites suggest doing your own taxes when they’re “simple” and paying someone when your details are “complicated” – how helpful is that when it’s all complicated? And just because we want to do something doesn’t mean that we can or should. I’m sure I could spend time doing my taxes but I just don’t want to. It’s easily worth it to pay someone to do the sausage making but I still try to understand all the numbers and strategy.

One example of the issues a potential DIYer has is the complexity of the data and documents they have to use to complete their return. There are lots of tax forms but let’s look at a couple of the most common in my industry, the 1099 Composite and 1099-R.

By the way, I don’t intend this post to be a super-detailed examination of each form. Instead, this is more of a shorthand way to look at them along with the sections and numbers I often look at as a financial planner.

Let’s consider the 1099 Composite:

As the name implies, this form includes an array of tax-related data such as dividends, interest, and gains and losses for taxable (not IRAs, Roth IRAs, or otherwise tax-deferred) accounts.

Schwab and other brokerage firms need time to review transactions made in their system and transactions and other data from investment providers like mutual fund companies. This data sometimes comes in late or gets revised after the tax year has closed. It’s for this reason that Schwab does two runs of these forms, the first in late January into early February and the second, for more complex accounts, in mid-February.

Assuming your accounts are at Schwab and also assuming they spent some time at TD Ameritrade last year, you’ll be getting two 1099 Composites for 2023, one from each company. The formats are different but the essential data is the same.

Delivery of these forms is usually electronic but you can have a paper copy mailed to you if that’s your preference.

Schwab’s 1099 Composite contains forms such as the 1099-DIV, the 1099-INT, and the 1099-B showing realized gains and losses. Those forms start the document after a couple of intro pages and then you’ll see summaries of each maybe midway through. These summaries aren’t reported to the IRS like the individual forms are. However, I like to look at the summaries first because they’re a little easier to follow.

For example, you can jump ahead to page 23 of 55 where summaries begin in the sample document below. But I often will jump ahead to page 31 (again, in this sample – yours may have fewer pages) to look at gains and losses first. I’ll review the totals to ensure accuracy and then work backwards to confirm the individual transactions look right.

https://si2.schwabinstitutional.com/SI2/Published/Direct/public/file/p-11092758

I’ll look for any large and/or unexpected numbers. Does anything appear to be missing? Maybe cost basis is missing? The information you see has been sent to the IRS so if anything is wrong you’ll need to have Schwab generate a new 1099 – you shouldn’t make corrections on your own. Otherwise, the 1099 Composite is a useful tool for assessing taxable activity for the year and that’s pretty much it. The document won’t give you rate of return information or investment analysis, but a clean form should give your tax preparer all they need.

Now let’s look at the 1099-R:

As with the Composite above, you’ll receive two 1099-R forms if you were taking distributions from your IRA while at TD Ameritrade and then at Schwab. Dividends, interest, gains, losses, and so forth aren’t normally reportable each year when they happen within a retirement account. All the IRS cares about is money leaving the account and why, so that’s what’s on the 1099-R.

That might sound simpler than the Composite, but it’s still challenging sometimes. Page 54 of 63 in the link below shows this form in detail.

I look at Box 1 for the year’s Gross Distribution amount, Boxes 4 and 14 for taxes withheld, and then Box 7 for the Distribution Code. This latter box can be problematic because sometimes the custodian codes a distribution incorrectly. These codes can have different tax ramifications so getting them right is key.

Code 7 is probably most common since it implies a “normal” distribution (meaning you’re old enough to draw without penalty and no other issues apply). All this is taxable as ordinary income.

Codes 1 and 2 are less common because they imply an early distribution that’s taxable as ordinary income plus a penalty, such as Code 1. Code 2 indicates there may be a penalty exception.

Also interesting is the box for “Taxable amount not determined”. This usually comes up when clients donated money to charity directly from their IRA. The gifted dollars aren’t taxable but Schwab doesn’t differentiate so they punt by checking that box. This leaves it up to the account owner to tell their tax advisor about the charitable gift but the box being checked typically flags the tax person to ask about it in case you’ve forgotten.

Other codes exist but review yours and let Schwab or your humble financial planner know if it seems wrong. Don’t manually correct it since the document needs to be reissued if there was a mistake.

Hopefully this helps you understand these tax forms a little better. I’m happy to help with further questions but specifics are probably best directed toward your tax advisor assuming you have one.

Here’s the guide I mentioned above.

https://advisorservices.schwab.com/resource/guide-to-schwab-tax-forms

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Crypto Chango

Did you hear about changes in the digital assets/cryptocurrency realm a week or so ago? The SEC approved the first physical bitcoin exchange-traded funds, or ETFs. Even if you’re not into crypto it’s good to have at least a general understanding of popular investment products, so let’s talk about it.

Now I don’t want to sound overly negative or kid around too much but hearing the term “physical bitcoin” reminds me of learning about oxymorons in grammar school. I remember thinking that pretty ugly seemed funny and illustrated the point. I wonder if kids today would understand how that applies to cryptocurrencies.

Anyway, when I look in my system I now see dozens of different investment funds related primarily or entirely to bitcoin including the 11 physical ETFs just approved by the SEC. These funds are referred to as physical because they track the “spot” price of bitcoin versus tracking futures contracts. The spot price is the price of an investment for immediate delivery and is commonly associated with commodities markets such as gold and silver. I don’t want to hammer you with too much jargon but this physical/spot concept is important to understand if you’re at all interested in buying funds that hold bitcoin.

I phrased my last point purposefully. While I’m sure it’s obvious to you, dear reader, that there is no such thing as physical bitcoin (beyond something commemorative) and that was partly why it was created, investment salespeople would prefer you to think that these physical bitcoin funds offer something fundamentally different from futures-based funds. They even suggest that buying these funds is better than buying and holding bitcoin yourself. And they have a point but I’ll get to that shortly.

You may be familiar with physical gold funds from providers like Sprott. If you want gold exposure in your portfolio you can buy and sell shares of something like ticker symbol PHYS. The fund holds gold bullion and lets you redeem shares for physical gold if you’re interested in doing so and hold a lot of shares. Their website says the redemption has to be equivalent to 400 oz of gold, nearly $810,000 at today’s gold price. That’s unrealistic for most ordinary mortals but knowing that the actual commodity backs their investment is comforting for many investors who buy gold for various reasons other than pure price appreciation. Granted, much of this is personal preference but that shouldn’t be discounted too much. For them, these funds are ideal because they indirectly hold the commodity conveniently within their existing investment accounts.

https://sprott.com/media/1058/phys.pdf

And that convenience factor is more or less the common denominator of the sales pitches from the bitcoin funds.

A good example is the Grayscale Bitcoin Trust (ticker symbol BTC but formerly GBTC). Other companies are in on this now too, such as Blackrock and Fidelity. But the Grayscale fund has been around the longest (incepted in 2013, originally as a private fund based on futures contracts), has the most assets under management (nearly $29 billion) and was one of the funds recently approved by the SEC to start tracking bitcoin’s spot price. Now that it’s an ETF you can buy and sell it within your existing accounts.

https://etfs.grayscale.com/gbtc?gclid=CjwKCAjwq7aGBhADEiwA6uGZp5Bc4HHPGO_Kqsc-pBott-3aQ5ncgM7opx05k40QoT9gB8SpLQPYGxoCdjgQAvD_BwE

Convenience is important but let’s dig a little deeper. The fund costs 1.5% per year while you hold it, about double the typical stock fund in the US but far more expensive than an S&P 500 stock index fund charging maybe 0.1% or less. I compare this to stock index funds because BTC tracks an index, the CoinDesk Bitcoin Price Index, much the same way a stock fund does. Maybe it costs more to manage a huge bitcoin portfolio but shareholders pay that management fee forever. The fund also doesn’t offer redemptions so you can’t swap shares for bitcoin. All you can do if you want out is sell your shares within your brokerage account. That’s straightforward and a reminder that, as I mentioned above, you don’t own bitcoin when you own these funds. Instead, you own shares of a fund that owns bitcoin. You get to participate in bitcoin’s price change, for better or worse, but that’s it. Now, one could say that’s like owning a stock index fund except that stocks represent real companies, many of which pay dividends, and most have long track records. Maybe bitcoin becomes a true currency but until then investing in it is pure speculation.

Maybe participating in bitcoin’s price change is enough for you but a lot of people who are interested in bitcoin also advocate for the democratization of finance, transaction privacy, and getting away from conventional markets. These bitcoin funds are the market.

So if you’re interested in owning bitcoin for any reason other than it’s price, I suggest shying away from bitcoin funds and instead buy and hold bitcoin yourself. You can do so at custodians like Coinbase and, while there’s some hassle there, the bitcoin will be yours and your transaction and holding costs will be a fraction of what you’d pay to the funds over time. Perhaps ironically, Grayscale uses Coinbase to hold its bitcoin so you’d be in good company.

Otherwise, if you’d just like some bitcoin in the overall mix of your portfolio and don’t care as much about the broader themes, these funds are perfect. Just understand what you’re buying and why. Bitcoin’s price is extremely volatile so you could dollar-cost-average into it or plan to buy on a major dip.

Also, it has been interesting to follow how bitcoin funds got to where they are today. Here are two press releases from the SEC about their recent fund approvals. The first is the general release while the second is a dissent from an SEC commissioner having to do with the likelihood for investor confusion and a misunderstanding of the risks of investing in cryptocurrencies in general.

https://www.sec.gov/news/statement/gensler-statement-spot-bitcoin-011023

https://www.sec.gov/news/statement/crenshaw-statement-spot-bitcoin-011023

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Predictions for the Year Ahead

Here we are again starting another year that is sure to be full of surprises. 2023 finished up nicely for the markets but now there’s some profit taking going on to start off this year. That’s understandable given recent performance as markets reset a bit for the year ahead. Investors, at least on average, are always looking forward so let’s spend some time on strategies and tactics for 2024. We’ll jump right in with expectations for bonds and plan to do the same for stocks next week.

I usually role my eyes whenever market strategists make annual predictions, but it’s part of their job and I understand that. Very much like weather reports, some market calls end up being accurate while others can be very wrong, but it’s still instructive to pay attention to them. I like to blend multiple predictions to get a feel for what’s expected instead of betting on one super-specific forecast.

One issue this applies to, yet again this year, is the Fed and what it may do to the interest rate environment as it continues to fight inflation. Here are a few predictions representing the current consensus.

JPMorgan expects/suggests (with at least a 1 in 3 chance of happening…) that the Fed cuts rates this year by 2.5%, bringing the short-term target rate it controls down to about 3%. This should help bond returns while also reducing mortgage rates and the cost of financing in general. One interesting thing about their prediction is that it doesn’t require a recession for the Fed to lower rates like this. Instead, it’s suggested that the Fed has room to do so while still being restrictive enough to bring inflation down from about 3% or so currently to the Fed’s 2% target.

Along these same lines Schwab expects rate reductions of about 0.75% from the Fed as a base case. Schwab’s predictions are usually pretty conservative and this one also doesn’t expect a recession but that economic growth and inflation continue to slow at a measured pace. Should we dip into recession Schwab expects that rate reductions could double to 1.5%. (By the way, Schwab’s base case essentially matches the Fed’s own rate prediction. The Fed was totally wrong in 2022 and it can be argued they mismanaged rates in the first place, but they nailed the 2023 forecast… maybe that accuracy continues in 2024?)

And then there’s the bond market’s own predictions. The CME Fedwatch Tool is a moving target representing where investors in the interest rate futures market are putting their money. For some weeks this tool has been showing market expectations similar to the JPMorgan prediction which is more “dovish” then the Fed expects itself to be this year. Bond investors tend to overshoot reality so checking in on this tool periodically is helpful as expectations evolve.

Other predictions abound but the majority are in this same vein. The obvious throughline is investors expect the Fed to cut rates this year by some amount and that any recession should be mild. A lot of this is already priced into the bond market but declining rates would be a welcome change, sort of a tailwind, for bond investors.

So what to do? Maybe you sold bonds back in 2022 or last year and have cash in a money market fund or bank CD that’s been earning 5+%. Funds like Schwab’s Value Advantage Money Market are still at that level but are tied to the short-term rate environment and often hold investments with maturities of 30 days or less. This means there’s a lag in how these funds respond to rate changes but they do respond. Bank CDs usually have rates that are guaranteed until maturity so mark your calendars for the maturity date if you haven’t already. Otherwise, your bank could roll you over into a lower-paying CD for another term. Currently, 1yr CDs are paying around 4.8% and this could drop to what come Spring or Summer? You want the opportunity to make an informed decision so that’s why you need to pay attention.

Assuming you agree with the general sense of these predictions as I do, it’s probably best to start working cash back into core bonds. You can do so incrementally or all at once, but I tend to favor the slow and steady approach as a way to handle uncertainty. Perhaps let declining money market rates or your maturing CDs be a signal for when to add more to bonds.

You can look at Vanguard Total Bond Market (available as a mutual fund or ETF, but I favor the ETF) or the iShares US Aggregate Bond ETF, or similar funds at Schwab, Fidelity, and so forth. These funds hold Treasurys, government agency and corporate bonds that are considered “investment grade” versus “junk”. The funds buy bonds of various maturities but these average to about medium in terms of interest rate risk and where the bond market is generally.

As a reminder, I’m doing all the above on your behalf if I’m managing your portfolio. Otherwise, and as always, feel free to ask questions.

Here are the links I mentioned.

JPMorgan…

https://am.jpmorgan.com/us/en/asset-management/adv/insights/portfolio

Schwab…

https://www.schwab.com/learn/story/fixed-income-outlook-rocky-road-bond-market

The CME Fedwatch Tool…

https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html

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Recasting Your Mortgage

I’ve received some questions about this and have recently gone down the decision road myself, so let’s talk about recasting your mortgage, how it works, pros and cons, and so forth.

What is a Recast?

Recasting a home loan isn’t refinancing. When you recast you’re working with the same loan terms, such as length and interest rate, while lowering your loan balance with a lump sum payment. Your lender then reworks your amortization schedule and lowers your monthly payment accordingly.

Here’s an example:

Say you’re five years into a 30yr loan with a $350,000 balance. At 3.5% interest your monthly principal and interest payment is about $1,796. If you paid $100,000 to the principal you’d now owe $250,000 with the same 25 years remaining. Your new payment would be $1,252, a savings of $544 each month for the life of the loan.

Why recast?

To save money, of course! The borrower in our simplified example would see their annual cash flow increase over $6,500 while also shaving off about $51,000 of interest expense if they made every loan payment. And you could potentially drop add-ons like private mortgage insurance if your loan-to-value ratio gets low enough, meaning more savings.

Here’s a good calculator to run an amortization schedule using your loan numbers. I’ve been using this guy’s site for years and it’s pretty straightforward.

https://bretwhissel.net/cgi-bin/amortize

Okay, so it’s clear why someone would want to recast but let’s consider the specifics.

You need to find out if recasting is possible since not all loan types and lenders offer this. My understanding is that FHA and VA loans don’t allow recasting, for example. Best bet is to reach out to your lender and ask.

Your lender likely has a minimum recast amount, such as $10,000 or maybe a percentage of your loan balance. Do you have that kind of cash sitting at the bank or maybe in a brokerage account? You won’t want to hit your retirement accounts for this so the cash has to be readily available.

There’s a processing fee and it takes a little time. My lender, Rocket Mortgage, had a $10,000 minimum, charged $250, and took about two billing cycles to lower my payment when I did a recast. And while they would have accepted a personal check I sent a wire transfer that cost $25, so add that cost as well.

Again, once the money is paid and the process completed you’re simply continuing your original loan terms but with a lower balance and payment. Recasting is really pretty simple but it’s not for everyone.

Here are some reasons why this may not work for you.

You don’t have an extra bundle of cash to put against your mortgage balance. Once you make the lump sum payment the only way to get the cash back is to borrow (assuming you qualify) or sell your home (assuming the market value remains high enough to cash you out). So this cash may be liquid now but it certainly won’t be when you’re recast is complete.

Also, while you can make extra principal payments on your loan anytime I don’t suggest paying a larger lump sum without first considering a recast. Doing so would save you interest expense over the long-term by paying your mortgage off early but would leave your contractually obligated payment the same in the meantime. Might as well reduce this too and give yourself some options since the recast expense is relatively low.

Your loan terms are bad, or at least not great. Maybe your interest rate is too high or maybe it’s an adjustable loan that you don’t intend to keep long-term. If so, maybe your financial situation has changed enough that you could refinance your loan instead of recasting. A good mortgage broker could help determine what you qualify for. If you think you fall into this category and have cash to put against your loan it’s reasonable to have a mortgage broker do a soft credit check so you can talk numbers. You could bring your cash to the refi to “buy down” your interest rate. And be sure to ask about the cost of any loan programs they mention. My recast cost $275 with the wire fee but the full cost of refinancing could easily be well over $5,000. Don’t make that decision lightly.

You’re not planning to stay in the home for at least the next five years. This is a facts-and-circumstances sort of thing but I suggest doing something else with your lump sum payment if this home isn’t a keeper.

You prefer maintaining your liquidity and, hopefully, are doing something productive with the money. My recast example used a 3.5% loan and a lot of homeowners are in that range now. You can buy 1yr bank CDs (at least right now) at about 4.9% and bond investments are there too with some potential upside (and downside but let’s be positive). Stocks have a higher expected return, of course, but I’ve always hated bringing stocks into comparisons like this because it’s really a different ballgame. Anyway, if the rate you’re earning on your excess cash is higher than your mortgage rate you may just want to ride that for a while. Or, like me, maybe you decide to keep liquid money working while also doing a recast – it’s great to have options.

Additionally, instead of a recast you could use extra liquidity to indirectly get more money into your retirement plan at work, fully fund your HSA, and maybe fund a 529 plan for your kids or grandkids. There are lots of options to consider and all are probably better than leaving a lump sum of cash to earn essentially nothing.

Ultimately, recasting a mortgage can be great for those who have a chunk of available cash, and a mortgage and home they prefer to keep a while. There are always other considerations but let me know if I’m missing anything important to you.

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More Predictions...

Whenever I hear someone ask about market predictions I think about one of the many famous quotes from the Rocky saga. This time it’s from Rocky III, probably my favorite. It’s minutes before Rocky’s big rematch versus Clubber Lang and the villain is asked by a sports reporter for his thoughts on the coming fight. Here’s that eloquent exchange in brief.

Clubber: “Prediction?”

Reporter: “Yes, prediction…”

Clubber: “Pain.”

And then we have the famous prediction of more than 100 years ago from either Henry Poor, a founder of Standard & Poor’s, JD Rockefeller, or JP Morgan himself on what stock prices will do in the coming weeks: “I think they will fluctuate.” Sometimes the best predictions are the simplest.

All kidding aside, I bring this up because predictions can have a lot of biases built into them and it can be hard to see through the clutter. In my industry there’s a lot of financial bias, so to speak, that can make predictions and longer-term forecasts can seem more like product pitches. My favorites are often from the “permabears” who constantly expect the sky to fall. They cherry-pick data to craft compelling stories about impending pain before offering their own complicated and expensive investment products or services as the solution. There are permabulls too, but they don’t seem to get as much airtime as their bearish counterparts. Fear sells, as they say.

I think the goal when looking at market predictions is to get a sense for what reasonable people (very subjective these days, I know…) are expecting the economy and markets to do during the next year so we can plan accordingly. It’s less about which hot stock or precious metals to buy and more about context.

In that vein let’s look at predictions for the stock market this year. We’ll stick with JPMorgan and Schwab and links to more details from each are below.

JPMorgan – Dr. David Kelly, the firm’s Chief Global Strategist is sort of a guru in my industry and frequently holds conference calls for advisory firms. I’ve been following him for years and one of things I like is that he’s a macro guy and doesn’t push products or services. Anyway, he’s someone to pay attention to and here are some tidbits from his (and from others within the firm) 2024 predictions.

2024 = 2% economic growth, 0 recessions, 2% inflation, and unemployment at 4%. This catchy description is what the soft-landing scenario we’ve discussed might look like. JPMorgan expects 2024 to be more volatile than last year but the generally positive economic backdrop is expected to help hold up stock prices even as prices reset to an environment of higher interest rates. A handful of stocks within the S&P 500 are pretty expensive compared to long-term averages while the rest of the index is more reasonably priced. JPMorgan favors large cap stocks this year but suggests buying companies with “resilient profits, solid balance sheets, and favorable relative valuations.” Basically, stay invested but batten down the hatches.

https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/Investment%20Outlook%20for%202024.pdf

Schwab – Liz Ann Sonders, the firm’s Chief Market Strategist, is always worth paying attention to. She and other strategists at Schwab suggest that while a traditional recession in the broader economy is still possible this year, a more likely outcome is a nuanced “rolling recession”, where some sectors struggle while others hold up well enough to average them out. That said, Liz Ann and her team at Schwab do seem a little dour, or perhaps just realistic, about our economy and the markets this year. Factors impacting this could be the declining financial health of consumers that has been showing up in reports lately and the yield curve being inverted for over a year, both of which usually imply recession.

The bond market may have adjusted quickly to the higher interest rate environment, but the stock market still has some catching up to do. Investors may be a little complacent about that, the firm says. Schwab is skeptical about current assumptions for corporate earnings growth and, like JPMorgan, suggests buying the stock of more profitable companies with manageable debt, not just those with huge (anticipated or actual) earnings and/or large debt loads. Diversification is important this year, Liz Ann says, and she emphasizes the importance of “adding low and trimming high” via rebalancing given the runup in portfolio values late last year.

https://www.schwab.com/learn/story/us-outlook-one-thing-leads-to-another

There’s no shortage of other predictions out there but many seem within range of these two. Let me know if you find one that seems interesting.

All in, these two forecasts present a mixed picture while not being overly negative. There’s still a low chance of a major recession but some sectors, perhaps Consumer Discretionary and Technology, could feel some pain assuming the broader economy slows as expected. Stock prices are high but that’s skewed by a handful of popular companies mostly having to do with those two sectors. Fed policy, and potentially unrealistic investor expectations about it, should keep playing a major role in market dynamics this year as well.

To me it’s wise to expect more volatility as investors have these and myriad other issues to contend with. And it being an election year will certainly impact investor psychology. But don’t worry about that too much. According to my research partners at Bespoke Investment Group, since 1928 the fourth year of the presidential cycle has been positive almost 75% of the time with a median return of over 9%. If this year matches that, I’ll take it!

That said, this sort of environment demands detailed portfolio construction and big-picture rebalancing of stocks versus bonds at the allocation level in your portfolio. It’s also important to diversify and rebalance within asset classes and styles (growth versus value) to ensure your portfolio isn’t overweight in potentially overvalued areas. Beyond that, it’s best to reset expectations for this year. Positive, yes, but never easy.

As I mentioned last week, this is happening already on your behalf if I’m managing your investments but I welcome your questions.

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Quarterly Update

The fourth quarter (Q4) of 2023 was an about face from the first nine months of the year. Just about every asset class was up almost the whole time and investors were optimistic. This, after investors had spent the bulk of the year on recession watch while punishing most stocks and bonds. Expectations about inflation, recession, and the Federal Reserve’s interest rate policies were the crux of market developments for the quarter and year before momentum finally turned positive in a big way during Q4.

Here’s a roundup of how major markets performed during the quarter and for the year, respectively:

  • US Large Cap Stocks: up 11.7%, up 26%
  • US Small Cap Stocks: up 14%, up 16.6%
  • US Core Bonds: up 6.8%, up 5.5%
  • Developed Foreign Markets: up 10.5%, up 18.9%
  • Emerging Markets: up 7.9%, up 10.3%

Most of the stock market’s 11 sectors limped into Q4 while major indexes leaned on a relative handful of stocks within the Tech, Communication Services, and Consumer Discretionary sectors for performance. AI enthusiasm boosted returns and companies in the S&P 500 like NVIDIA, Meta (Facebook), AMD and Tesla were each up over 100% for the year, far outstripping the index’s return. Much of the rest of the stock market spent most of the year in mixed territory and suffered several demoralizing slumps as the months ticked by. Sectors such as Healthcare, Energy, and Utilities finished the year down a bit. In fact performance and the general environment (multiple wars, bank failures earlier in the year, and lingering concerns about inflation to name a few of the issues present) created enough uncertainty that investors spent much of the year feeling quite bearish about investing.

From about late summer the stock market began another of its downward slides that eroded returns across markets well into October. Indexes with less tech exposure to help hold them up, such as the Dow Jones 30, were pushed into negative territory and the nascent recovery from bonds was smashed. The numerous reasons for this went back to the Fed and what they might do with interest rates.

Investors saw the Fed pause rate increases during the summer but were expecting plans to cut rates. That wasn’t materializing fast enough for investors and the central bank remained hawkish about its willingness to fight inflation. Interest rate sensitive sectors and the bond market saw values suffer as rates continued rising even while the Fed was in pause-mode. The 10yr Treasury, a key benchmark, rose to 5% in late October and that ultimately marked a turning point. Investors began feeling certain that interest rates had risen high enough and that the Fed would start reducing rates early in 2024. This was eventually confirmed, more or less, by the Fed Chair during Q4. Investors cheered this change in direction and bought bonds, sending the same 10yr Treasury yield that had recently been so worrisome back down below 4% as the year closed.

This long-awaited dovish tilt for the Fed sent markets soaring throughout November and December. Almost like flipping a switch investors turned bullish, pushing top performers higher while lifting asset classes and sectors that had been lagging. As you can see from the performance numbers mentioned above, core bonds can thank Q4 for their positive performance and emerging market stocks can too. Another example of the rapid sentiment change came from US small cap stocks which saw their primary index change from a 52-week low to a 52-week high in just 48 days, the shortest timeframe ever according to my research partners at Bespoke Investment group.

One takeaway from Q4 and last year as a whole is that market volatility works both ways. Downside volatility is scary because it can happen fast but prices can rise just as quickly. Bespoke also shared that the turnaround for a typical 60/40 (percentage in stocks and bonds, respectively) asset allocation did well last year but much of that growth occurred during the last two months. That recovery was nearly as fast as coming out of the Covid market lows in 2020. Does anyone think the environment last year was that bad? Regardless, the collective will of investors around the world can change rapidly and has the tendency to create a sense of whiplash and of being left behind.

The outlook is good as we enter 2024. Goldman Sachs publishes an index of financial conditions and, due primarily to the Fed policy shift already mentioned, conditions swung from tight to loose quickly during Q4. In the past that has boded well for markets and the economy a year out and this helps fuel the current positive narrative. But as we know, dominant narratives and investor sentiment can turn on a dime so it’s best, as always, to be cautious. Some analysts suggest that stocks are priced for perfection and that investors could be overly optimistic about Fed rate cuts, so some amount of pullback should be expected even in the context of a continued bull market.

The repeated lesson from all this is to double down on planning, ensure your portfolio makes sense relative to your plans, and then stay the course while making necessary adjustments along the way. Growth will happen but it takes time and demands intestinal fortitude. Nothing is free but staying calm and disciplined while others around you are panicking is as close to a free lunch in the investing world as you’re likely to get.

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