I hope your summer has been going well so far. We’re now well into the second half of another eventful year and I realize I haven’t taken a break from writing my blog yet. I try to do so twice each year, once in winter and again during summer, to spend a little more time with family.

Even though these posts will pause for a bit I’m still hard at work, so feel free to reach out with any questions or concerns. Otherwise, I’ll be back to these pages soon, likely with news about new planning software I’ve been reviewing. This new tech lets us test a client’s income plan against relevant historical time periods, such as bouts of high inflation, world wars, market crashes, all that fun stuff. Should be interesting and valuable as a stress-testing tool.

Have a great rest of your summer!

- Brandon

Have questions? Ask me. I can help.

Are we in a recession? We touched on this question last week and it’s worth revisiting for a few minutes this morning. Recessions are nebulous things, difficult to pin down in the moment, and everyone has an opinion. The dates and other specifics around a recession are important, however, so it’s good to understand some of the fundamentals.

There are multiple ways to define a recession. The typical back of the envelope method is seeing at least two consecutive quarters of declining GDP. The first quarter of this year saw GDP fall over 1%. The second quarter was on track to be flat, or perhaps slightly negative and, if so, you could say we’re in a recession now. Seems pretty simple. But as with most simple things there’s always more to the story.

For starters, most of us view the question from a non-academic perspective anyway. If we feel like we’re in a recession, we’re in one. Opinions about this are perhaps informed by the feeling of moving backward due to inflation and the sense of inevitability it brings. For others it’s the loss of a job setting them back for weeks if not months. Others bake politics and overall sentiment into how they see our economy getting better or worse. By this sort of reckoning some suggest that we’ve been in a recession for years. Again, lots of opinions. Last Friday was the 43^rd anniversary of President Carter’s “malaise” speech and, if nothing else, listening to it in our current environment provides an eerie reminder of just how closely history can rhyme.

But there’s a broader, formal definition of recession that’s generally considered correct. A committee within the National Bureau of Economic Research (NBER) looks for a “significant decline in economic activity that is spread across the country and lasts more than a few months” before calling the beginning and ending of each recession. NBER tracks a variety of information and focuses on the “direction of change” to find the peaks and troughs occurring over time within our economic cycle. All this is dependent on data that takes time to assemble and is why recessions are identified only after the fact, sometimes well after because the data often go through multiple revisions. NBER’s work is also subjective because they decide how important some metrics are versus others at a given point in time.

That brings us to my main point this morning. Recessions often follow a general playbook but no two are exactly alike. And our next one, whether it’s now and NBER just hasn’t named it yet, or is down the road, it’s likely to be very different from prior recessions due to the dislocations (for lack of a better term) caused primarily by our response to the pandemic. For example, there’s a large number of available jobs in our economy even as economic activity slows. No prior recession since WWII has seen this combo. Is the job market just waiting to roll over? Why are companies still posting jobs if, as some suggest, the outlook is so poor?

Along these lines, here’s a five-minute video that does a great job describing the complexity of our current environment. Let me know if you get blocked by the paywall and I can try to send you the link direct from my account.

https://www.wsj.com/video/series/wsj-explains/why-a-2022-recession-would-be-unlike-any-other/52127788-B3C8-496C-A31F-B6127425F4BC

And here’s a link to FAQs on NBER’s website to get more information on how they do what they do.

https://www.nber.org/business-cycle-dating-procedure-frequently-asked-questions#:~:text=A%3A%20The%20NBER's%20traditional%20definition,more%20than%20a%20few%20months.

Have questions? Ask me. I can help.

The second quarter of 2022 (Q2) was one that most investors were anxious to put behind them as it rounded out the worst first half of a year for stocks in five decades. Inflation, Federal Reserve policy decisions, and recession fears supplanted Russia’s February invasion of Ukraine as the key issues for markets. And as sentiment followed stock prices down throughout the quarter you had to squint to see the few bright spots along the way.

Here’s a roundup of how major markets performed during Q2 and year-to-date, respectively:

• US Large Cap Stocks: down 16.1%, down 20%
• US Small Cap Stocks: down 17.3%, down 23.5%
• US Core Bonds: down 4.6%, down 10.2%
• Developed Foreign Markets: down 13.2%, down 18.8%
• Emerging Markets: down 10.4%, down 17.2%

Stock prices around the world fell during the first quarter, but declines accelerated during Q2 as risk assets in general were hit hard. Bitcoin and other digital assets suffered major losses due to overall risk-off sentiment and some heavily-levered (and simply ridiculous) portions of that market fell apart. US Large Cap stocks as measured by the S&P 500 entered a technical bear market (a 20+% decline from a recent high) during Q2. Losses came quickly with multiple stretches of back-to-back 1% - 3% declines and a 10+% drop during one week in June. The tech-heavy NASDAQ 100 ended the quarter down about 28% year-to-date, with most of that decline occurring in Q2. Within the various market sectors, Communication Services and Consumer Discretionary put up the poorest showing, down about 23% and 26%, respectively, for the quarter and 30% or so year-to-date. The only positive sector in the US has been Energy, up around 31% year-to-date while still posting declines of about 5% during Q2.

Driving much of the poor performance was evolving concerns about inflation and how the Fed would react to it, continued pandemic-related supply chain and commodity markets disruptions due to Russia’s invasion of Ukraine (which helped the Energy sector), and the interconnectedness of it all potentially leading to a recession.

Inflation hit 8.6% during May, a multi-decade high, with prices for housing, gas, and food the largest contributors. This price surge kicked into gear last October but really caught up with markets and the Fed during Q2. Some miscommunications about the perceived seriousness of the inflation problem accompanied two rate increases from the Fed, 0.5% in May followed by 0.75% in June, the largest increase since 1994. During Q2 the Fed reaffirmed (or shifted gears, depending on your perspective) that its first job, maintaining stable prices, is required to handle their second job of maintaining full employment within the economy. The Fed’s primary method for tempering inflation is to slow the economy by raising interest rates, a blunt tool that is tough to wield without triggering a recession. Investors grappled with this during Q2 without any meaningful resolution as the quarter closed. Accordingly, the aforementioned few bright spots occurred around soothing words from the Fed about future rate increases or data showing an economy already slowing, implying the Fed could raise rates less aggressively and be less likely to make things worse.

Bond prices fell less in Q2 than during the first quarter and provided some support to portfolios but were still volatile due to the same issues impacting stock prices. The broad bond market fell about 4% during Q2 and is down about 10% this year. Bond yields rise as prices fall and the 10yr Treasury yield, a key benchmark, rose to 3.6% before closing out the quarter at about 3%. This caused the average 30yr mortgage rate to briefly hit 6.3% before backing a bit as Q2 ended – but still almost double where it was just six months ago. These rapid changes in bond yields and the cost of borrowing act as roadblocks for inflation but could also help spur a recession.

The outlook was mixed for much of Q2, and little clarity exists as we begin the second half of the year. A variety of economists and market watchers continue to scratch their heads at the odd juxtaposition of data showing continued pent-up demand for certain goods and services in our economy and a strong job market, coupled with declining consumer sentiment and confidence about the future. Most economic indicators seem to be telling us that we’re not in a recession now, while some appear to be rolling over. And the inflation problem was showing some potential signs of moderating as we closed Q2. All this complicates any clear narrative about the near-term path for growth. In short, the economy isn’t following the typical playbook and this, perhaps in hindsight, should have been expected after such a tumultuous period.

Numerous market sentiment surveys were flashing red as we ended Q2. For example, a survey from the Conference Board found that only 26% of respondents expected higher stock prices a year from now, a ten-year low. In light of this it’s understandable that some retail investors have been throwing in the towel. But history shows that such poor sentiment usually leads to strong returns a year out and is why such survey results are viewed as a contrarian indicator. For us, amid continued uncertainty the main job continues to be ensuring our portfolios are set up correctly, rebalancing as needed, and buying stocks and bonds on weakness as appropriate. This isn’t much fun during times like these, but the decisions we make today will absolutely impact our tomorrow.

Have questions? Ask me. I can help.

As strange as it may sound these days, we need inflation. Our population grows and so must our economy. Without inflation, over time we’d see a decline in our standard of living and eventually lose our position in the world. But the trick is having the right amount of inflation. Unfortunately that’s an incredibly hard thing to manufacture in an immensely complicated and interconnected economy, and world, such as ours.

The Federal Reserve had long targeted 2% per year as being the Goldilocks number for inflation. As you may recall, pre-pandemic the Fed was struggling to get inflation even that high. Then in 2020 the Fed started thinking about its inflation goal as an average over time versus a specific annual target. The idea was to let the economy run hot for a while before cooling it down if needed, ultimately getting to that sustainable, just right average. The Fed, by its own admission, misdiagnosed how quickly inflation would rise and has been racing to catch up, likely with another 0.75% rate increase this week (cooling the economy by ice bath versus a hand fan).

So we need inflation to keep our economy healthy, but too much leads to a variety of impacts that we’re now seeing play out more or less in real time. Inflation hits low-income folks and young people hardest, but the pain of quickly rising prices and its knock-on effects is being felt across the age and income spectrums.

Along these lines I wanted to share links to a couple infographics with you.

The first is from USA Facts, an interesting website that pulls together a variety of government data on a host of issues. In this case it’s repurposing inflation data from the Bureau of Labor Statistics to show how inflation is impacting different age groups. Maybe this is telling us what we already know, but it’s helpful to compare our personal situation to a bigger-picture view of inflation across the lifecycle. The page lets you slide between ages to see how the overweighting of rent cost shifts to home ownership in one’s 30’s, for example, while spending on gasoline typically declines as one ages, with the drop off beginning in the 40’s. 

USAFacts.org

The second infographic is from The Wall Street Journal and provides a deeper dive into BLS inflation data. The various items BLS tracks are color coded by price change over the past year and there’s a lot of information to check out. For example, prices for “Fresh Whole Chickens” and “Frankfurters” rose 15% or so in the past year, while “Smartphones” fell about 20%. The WSJ refreshes the data monthly, I believe, as the BLS publishes updates.

The tool also lets you create your own basket of items, perhaps mimicking your typical spending habits. As with USA Facts above, in a sense this is telling you what you already know from experience, but it’s still interesting to see how prices have changed over the past year in the official government data. My basket started with almost 19% inflation in June of 2021 but crept up to 33% by last month, driven largely by gasoline, men’s footwear, and citrus fruits. Go figure.

The WSJ Inflation Tracker

Have questions? Ask me. I can help.

Now that we’ve hit the ground running in the third quarter I wanted to share a few different items with you. First are a couple of surprising stories I read over the weekend. And second is some quick commentary and a chart that will hopefully be reassuring amid all the talk of recession lately.

Now, I’m closer to this sort of information than the average person and I also tend to focus on risk more, but this first article is a reminder of how bad things can get when new financial products come to market faster than the regulators can pay attention.

I’m talking about the rapid rise and dramatic fall of so-called high-yield savings accounts built on the back of digital assets like Bitcoin, Ethereum, and smaller cryptocurrencies. These were all the rage when Bitcoin, for example, was riding high. But as prices fell precipitously so did the shaky foundations that many of these companies were built on.

In this case it’s the bankruptcy filing last week of Voyager, a company that wooed depositors with high interest rates on crypto deposits that could be easily converted into dollars and spent via a debit card. The company’s marketing implied safety and security while being anything but behind closed doors. Ultimately while maybe not a total sham, at a very charitable minimum the company seems to have made light of the variety of risks to depositor’s assets. This led regular people to deposit more and more of their savings, thinking that they were doing the right and responsible thing and, oh yeah, that they were being well-compensated for it along the way.

Did these folks never play the game of musical chairs? Did they not do a basic sniff test to gauge how solid it was to receive high yields on deposits (Voyager touted up to 9% - other companies into the teens) when real banks were offering less than 1%? Nothing is free in this world and financial institutions aren’t in business to give money away. Higher-than-average yields should always smell risky – there has never been a time when this wasn’t true.

There’s absolutely a place for risk in your financial life. We willingly take it with stocks and bonds every day. But we also consciously limit our risk by having a clear line drawn between money that’s investible for long-term growth and what we need to keep safe for shorter-term needs. Blur these lines too much and you’re bound to have problems when markets turn.

I don’t entirely fault the individual depositors referenced in this story. They were enabled by being sold a bill of goods by Voyager and an emerging industry that, I believe, is less concerned with the future of digital assets as a great democratizer of finance than making millions off the backs of unsuspecting and naïve consumers. The game is as old as time. It’s just shocking how easy it still is.

https://www.vice.com/en/article/g5vgqw/its-ruined-me-voyager-customers-fear-life-savings-gone-after-crypto-firms-bankruptcy

The next article has to do with the average car payment in the US rising to $712 per month. Maybe I’ve been living under a rock but, wow, that seems like a lot of money. And that’s just the average, implying that lots of folks are driving around with a car payment much higher than that. This was originally reported by NPR based on data from Moody’s Analytics.

According to Moody’s, it takes about 41 weeks of a typical person’s income to buy a new vehicle these days, up 14% from a year ago. Supply-chains and inflation are blamed, as is a slew of gadgets and upgrades bringing the average sale price to over $47,000. This seems unsustainable, at least for the typical person, but data from other sources doesn’t show a big uptick in late car payments yet. So long as the economy holds out people should be able to afford these payments.

https://www.npr.org/2022/07/02/1109105779/monthly-car-payments-record-700

Along those lines, here’s a couple of items from JPMorgan regarding the economy. Ultimately, it’s a mixed bag in terms of positive readings versus others that appear to be rolling over. But a big indicator is the job market, which appears healthy. It’s tough to be in a recession when that’s the case.

Here are some recent thoughts from JPMorgan on the “Are we in a recession?” question:

[…] Recently, recession fears have bubbled to the surface, as the Federal Reserve Bank of Atlanta’s “nowcast” of economic growth now points to a contraction [in this quarter]. This tracker – appropriately named GDPNow – […] suggests that 2Q22 real GDP will decline 2.1% due to a significant slowdown in consumer spending and a contraction in private investment.

[…] Looking ahead, we recognize that recession risk has risen. That said, it seems premature to make a call that we are already in recession today. To start, the labor market remains robust, with job openings still elevated, wage growth solid, and payroll employment growing at a rapid clip. Furthermore, many of the pain points in the economy have begun to correct themselves – commodity prices have come off the boil, inflation looks to have peaked, and market expectations are now for the Federal Reserve to begin cutting rates in 2023.

For investors, it is important to remember that markets are forward looking. Put differently, the equity market tends to peak before a recession starts and trough before the economic data begins to improve. While risks to the outlook have risen, valuations have become more favorable and sentiment is beginning to look washed out; this is not an attempt to call the bottom, but rather a recognition that the outlook for risk assets is more favorable today than was the case at the start of the year.

Have questions? Ask me. I can help.

With all the recent market volatility I thought it would be interesting to lift the curtain a bit on one aspect of how I manage client portfolios, my rebalancing process. This might provide some insight and perhaps some reassurance if I’m managing your investments, or perhaps a bit of help if you’re managing things on your own.

First let me say that setting up and managing a portfolio of investments entails both art and science. There are also tons of details to get your arms around and most are in constant flux. I have to think about the markets, the outlook, taxes, brokerage firm mechanics and expenses and, above all, what the client needs. None of this guarantees success. Instead, portfolio management is fundamentally an exercise in trying to control what can be controlled regardless of what the markets throw at us.

So hopefully without getting too deep into the weeds, let’s jump right in.

Everything I do for my clients is custom and based on factors such as:

General needs – Maybe the client needs retirement income or is trying to accumulate money for retirement. Sometimes, perhaps ironically, it’s both at the same time with the added kicker of wanting to preserve as much money as possible for beneficiaries.

Tax situation – I’ll often build portfolios around concentrated positions that would create a large tax bill if sold arbitrarily. It’s also common that clients need their income to be as tax-efficient as possible. Both requirements end up complicating portfolio construction and put added emphasis on so-called asset location. This is especially true when clients have IRAs, Roth IRAs, non-retirement “brokerage” accounts, and maybe college accounts for their kids and grandkids too; each are subject to different tax rules and should be invested accordingly.

Personal preferences – Sometimes clients want to emphasize (or deemphasize) certain industries or even particular companies in their portfolios. The process for getting this done has evolved a lot in the nearly 20 years I’ve been doing this work and software helps a great deal.

Risk tolerance and capacity – Each of us has our own tolerance for investment risk but we should also understand our capacity for taking it on. The first is psychological while the second is, or at least ought to be, purely financial. Sometimes the two align but often they don’t. The result tends to be a sometimes-tenuous balance between taking enough risk to achieve the returns I know the client needs but not so much risk that I set the client up for failure in a volatile market. And it doesn’t always work.

I have a variety of tech at my disposal to automate the investing process and lots of others in my industry simply farm this work out to third parties. “Freemium” and ultra-low-cost cookie-cutter services are clicks away. But opportunities can get lost in the rush to make everything easier. While there certainly are some similarities between Clients A, B, and C, the differing details of each person’s situation are plentiful and meaningful enough that investment models, and the work I do in general, should be custom.

A client’s model is essentially a list of investments chosen by me to a fill a specific need within the portfolio. Each investment has its own weighting and I put this into fancy software to analyze the model and tweak things until it’s just right. I make decisions about investment income, expenses, exposure to domestic versus foreign stocks, short- versus medium-term bonds, and so forth. There’s a laundry list of analytical stuff that I won’t bore you with here.

Once the model is set up I send it to my rebalancing software. From there I don’t just push a button and let an algorithm buy and sell on a client’s behalf. Instead, I set and monitor target ranges around each investment in a client’s account. For example, let’s say I want 12% of a portfolio invested in the Vanguard High Dividend Yield ETF, ticker symbol VYM. The software flags me when the target weighting has dropped by 10%, 15%, 20%, or whatever I want. If the position has grown too much the software recommends selling some to bring it back within range. And since growth in one area naturally means loss in another, the software also points out investments that are at the low end of their target range. This is rebalancing at the micro-level whereas most people go macro by just looking at their overall exposure to stocks and bonds assuming they rebalance at all.

Each week I go through all the portfolios I manage but during volatile times like these it can be daily. This higher frequency is mostly to monitor things as closely as possible and doesn’t mean that I buy and sell every day. In fact, it’s often about what I don’t do, what I don’t buy and sell, that can make a positive difference for clients. That’s one reason why the thresholds are ranges and not 0% - portfolios should be allowed to move around with the markets so long as the range is controlled.

As I monitor the rebalancing process I’m also scrutinizing each investment to ensure it’s still high quality, low cost, and continues to fit within the portfolio. Since I’m unconstrained in what I can buy for clients I’ll swap an investment out if needs be, or I can move things around for tax-loss harvesting.

Here’s part of a screen showing an actual model from yesterday. The investment ticker symbols are on the left followed by my target weightings, actual (current) weights, and variance. We see the software’s recommendations in the yellow column and on the right we see what the portfolio would look like if I said yes to everything. That’s the big picture. Then I consider the client’s situation.

This client has ample cash in their portfolio (and in their bank account) and the 3.5% variance is fine, so we’ll leave that alone. No other variances are beyond even 10%, so we’re good there for now. However, lately I’ve been buying Vanguard Total Stock Market, ticker symbol VTI, and the client’s exposure has inched up with the market. Should it continue to climb I’ll be looking to trim it back and give sale proceeds to bonds via tickers MWTIX, BCOIX, potentially to foreign stocks via VGK, or all three. You may notice how the software is recommending I go up to 19.5% variance on BND, another bond fund. That’s because I put a cap on MWTIX and told the software to recommend BND instead. There are all sorts of fun customizations like that.

All this helps a client’s bottom line over time, and I could go on but let’s leave it there for today. Stocks finally had a good run last week and we saw some decent follow through yesterday. Even though markets finished in the red, it was by a small fraction and, given all the recent volatility, I’ll take it.

Have questions? Ask me. I can help.