Welcome to 2024

It’s an election year and America will vote in November for a new Congress and President. Regardless of the election outcome, some investors will be pleased, while others will be disappointed. This article will help investors understand how the markets have been influenced when different political parties take control of both Congress and the Presidency. Looking at data from 1926 through 2023, the main conclusion is straightforward:

Over time the markets tend to rise, regardless of which party controls the White House or Congress.[1]

What impact does the President have on the stock market?

Democratic presidents have overseen slightly higher stock returns compared to Republicans. However, this difference is minor and not considered statistically significant. The variance in stock returns under different political parties can be attributed to the random chance of who happened to be in power at a given time. The reality is the US economy is vast and intricate, making it challenging for any individual, even a powerful figure like the President, to completely control its direction.

A recent example is the presidential election of 2016. The general expectation was for Hillary Clinton to win. When Donald Trump unexpectedly secured victory, initial market reactions led to a decline. By the following day’s market close, markets had not only recovered from the dip but ended up positive on the day. It’s hard to know how the market will respond to unexpected information, and it’s equally difficult to predict what impact a President may have on the stock market.

What impact does Congress have on the stock market?

On the other end of the federal government, a Republican-controlled Congress has typically overseen the best stock market returns. The differences are minor enough that there’s no certainty which party controlling congress (or a split) is best for the stock market.

Congress can be the more impactful part of the federal government in the long run. Executive actions are easily overridden day one by a President from the opposing party taking office. Legislation tends to be more enduring due to the requirement for a larger number of people to be involved. It’s important to note that the effects of legislation may take years to become apparent. This time lag makes it extremely challenging to pinpoint and attribute specific policies to their respective impacts on the ever-evolving dynamics of the market.

What about the White House and Congress combined?

When you widen your lens to encompass both the White House and Congress, the narrative remains consistent. Markets tend to go up irrespective of political control.

Regardless of the federal government’s control scenario, markets go up more often than they go down. 

As the 2024 elections unfold, we urge investors to remember that investing is a marathon, not a sprint. Position your portfolio to be successful in the long run, enabling it to weather unexpected changes from any source. Both parties have experienced periods of positive and negative returns while in power. Despite the inevitable changes in government, companies exhibit resilience and innovation, consistently discovering avenues to yield returns for their investors. In the intricate dance of politics and markets, a steadfast and forward-looking investment approach proves to be the key to enduring success.

Sources:

[1] Equity returns are monthly returns for the Ibbotson SBBI US Large-Cap Stocks Total Return for Jan 1926 thru Oct 1989 (data courtesy of the CFA Institute & Morningstar Direct), and the S&P 500 Total return for Nov 1989 thru Dec 2023 (data courtesy of YCharts)

Data for which party controlled both houses of Congress and the presidency is from the history.house.gov website (https://history.house.gov/Institution/Presidents-Coinciding/Party-Government/)

Changes to Congress and the Presidency are assumed to occur Jan 1st of odd years. A split Congress indicates that each party controls either the House or Senate, but neither party controls both.

Appendix: Bonus Chart 📈

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In recent months, I’ve been pondering the US labor force and how it has changed in the last five years. Amid the ongoing conversations surrounding inflation and the Federal Reserve's (aka The Fed) recent decisions to raise interest rates to manage inflation, I don’t want to neglect the other part of The Fed’s dual mandate: the dynamics of unemployment and the labor force. Prior to COVID-19, unemployment was at 3.5%, the lowest rate in the last 50 years. Today unemployment is around 3.8%, and has been 4% or lower since December 2021, significantly below the median unemployment of approximately 5% the US has experienced over the last 25 years. Since March 2021, job openings have consistently surpassed the number of job seekers.

Unemployment is often considered an indicator of an economy’s health. Like inflation, you want some unemployment, but not too much. Too high unemployment indicates a weak economy. If unemployment is too low, high inflation becomes a concern. Businesses seeking to grow may be constrained because of a lack of workers, limiting overall economic growth.

Strong employment is a major reason why 2023 has not experienced the recession that many feared at the beginning of the year. I wanted to delve into the reasons behind the tight labor market, what can be done about it, and what this signifies for the overall economy.

Labor’s impact on the current economy

The fundamental assumption in most economic models is that production is constrained by two primary inputs: labor (i.e. workers) and capital (i.e. technology). While technology has yielded significant advances in productivity, the necessity for a workforce to drive economic growth remains. A shortage of labor would imply slower economic growth, potentially resulting in reduced stock market growth.

Concerns persist regarding automation displacing jobs. Some have even proposed the implementation of a universal basic income due to the scarcity of employment opportunities resulting from automation (as exemplified by former presidential candidate Andrew Yang, who made this a central theme of his campaign). A variation of this concern has been present for over a century.

The latest development in automation centers around AI potentially increasing productivity to the extent that we might encounter a surplus of labor. Numerous case studies illustrate that technological change does not always materialize as successfully or rapidly as initially projected. A decade ago, there was much buzz about how autonomous cars were poised to revolutionize the world. Substantial progress has been made, but the challenge of perfecting driverless cars has proven more intricate than many had anticipated. (An example is Moral Machine, where you weigh in on how a self-driving car should navigate situations where the car must choose who to protect in an unavoidable collision).

Another illustration can be found in the excessive optimism at the peak of the dot-com bubble. While the internet did transform the way we work and introduced new efficiencies, it took significantly longer than what people in 1999 had envisioned. Forecasting the timeline for technological change impacting worker productivity is challenging.

If I had to guess, I would anticipate that in the near term (i.e. the next 5 years), we will continue to experience a tight labor market that will be a headwind to growth, for the economy and the stock market.

Retiring baby boomers present a significant challenge

By 2030, the youngest Baby Boomers will turn 65. The average American retires at 64. These retiring Baby Boomers possess the most expertise and would ideally be succeeded by Gen X workers with slightly less experience. However, Gen X is too small of a generation to fully replace the baby boomers, and Millennials & Gen Z broadly lack the experience necessary to fully replace the skills of retiring baby boomers.

This is backed by recent projections by the Bureau of Labor Statistics (BLS), showing that total employment is expected to grow by only 0.3% annually for the next decade, with a significant constraint being the slower growth of the working age population. Slowing growth in labor likely means slowing growth in GDP and stock prices.

Furthermore, there has been a consistent decline in the labor force participation rate over time. This is a measure of everyone 16 and older who is not in the military or an institution (due to criminal activity, mental health, or aging). Part of this reflects the aging population. As the proportion of the population beyond retirement age increases, a smaller segment of the population remains in the workforce.

How can we increase labor?

Gen Z is entering the workforce, but as a generation, they are too small to completely replace retiring baby boomers. Producing more working-age adults takes at least 16 years and 9 months, and the US birthrate has been below the stable replacement level of 2.1 for most of the last 50 years. If the US wants to sustain long-term population growth, and consequently, workforce expansion, it must either depend on immigration or find ways to boost the birth rate.

Implementing a policy permitting increased immigration could boost the size of the workforce in America. However, this is a politically contentious issue, and the legal framework around immigration is too uncertain to make reliable long-term predictions. Overly restrictive immigration policy could lead to a labor shortage, and too permissive immigration policy could cause a labor surplus. Foreign workers constitute approximately 20% of the US workforce.

A tighter labor market has some benefits for workers

The scarcity of labor translates into more choices when seeking employment and enhances the bargaining power of job seekers. Companies will have to consider their recruitment and retention policies to ensure they have the workers required for optimal performance. US wages and salaries are remaining above inflation, showing workers ability to demand higher compensation.

A tighter labor market plus higher wages could equal higher inflation rates

However, higher wages also entail increased costs for companies, and the allocation of these costs, whether to customers or shareholders, may result in higher inflation or reduced earnings. To counter inflation, the Federal Reserve has been increasing and maintaining higher interest rates. Many are apprehensive that the tight labor market (associated with demand-pull inflation) and ongoing post-COVID supply chain challenges (linked to cost-push inflation) could make achieving the long-term target of 2% inflation more challenging.

In Q3 2023 we observed inflation rates increasing from just below 3% in June to 3.7% in September. Many consider unemployment and inflation to have an inverse relationship. A tighter labor market may necessitate the Federal Reserve to persist with a more extended and aggressive tightening policy to manage inflation. If the Federal Reserve becomes overly aggressive in its tightening efforts, the concerns that led many to anticipate a 2023 recession could materialize.

All of this hinges on the tight labor market persisting. Technological advancements have the potential to enhance productivity to a level where a smaller workforce can achieve more and sustain economic growth. Modifications in immigration policy could either introduce a new source of workers or further reduce the size of the workforce.

In the long run, successful companies will adapt to the new environment and thrive. A diversified portfolio will continue to capture the growth of the companies that excel. We encourage investors to be prepared for a myriad of reasons to be nervous, and understand given time the market will figure things out and continue to grow.

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A much needed update for families

The Free Application for Federal Student Aid (FAFSA) Simplification Act of 2021 was passed by Congress for many reasons. For starters, the calculation was originally defined over four decades ago in 1972 and is in some need of updating. According to the National College Attainment Network (NCAN), only 61% of seniors applied for aid in 2017 and 54% in 2021.

Some consider COVID to be the main culprit for this sudden drop, but the complexity of the form is the other main issue. Currently, students are required to answer 100+ questions depending on their family's income level. As of now the new FAFSA form changes are set to be released in December 2023 and students and parents alike need to be aware of the specific aspects that will apply in the 2024-2025 academic year that may impact aid eligibility depending on their family situation.

What’s changing and why it matters

1. EFC (Expected Family Contribution) replaced with Student Aid Index (SAI)

Short answer: Fairer access to funds for lower-income households.

One of the more obvious changes was renaming the EFC to the SAI. The goal was to not only reduce the confusion around the actual costs of college and what families are responsible for paying but also ensure access to Federal Student Aid programs including Direct Student Loans, Parent PLUS Loans, Work-Study programs, and even Pell Grants for low-income households. This number can be negative with maximum Pell Grants awards giving a student up to -$1,500 in money back. Time will tell but the largest impact will fall on middle to upper income families who will no longer be able to divide the number of college students in the household that are currently in college. For example, a family that could pay $40k/year could split the aid evenly between the number of students in college at the time. They no longer have this luxury and will see a reduction in aid.

2. Custodial parent status changes

Short answer: For non-married couples, the parent who ultimately claims the child as their dependent on their tax return will submit the FAFSA.

Currently, the FAFSA only collects income and asset data from the parent a student lives with. In cases of divorced, separated, or non-married couples who reside together starting in 2024-2025 school year, the SAI calculation factors in the parent who provides the greatest financial support. In cases of divorce and separation starting in 2023 the SAI calculation will only require the parent who provides the majority of “support” to fill out the FAFSA. One household might pay the child support but the other pays for the mortgage, groceries, and sports clubs. The implications of this decision can be significant.

3. Formula changes

Short answer: Students can qualify for more awards.

As with the SAI calculation, the number of students a family has in school is no longer a factor for Pell Grant eligibility. By completing the FAFSA, you are considered for the maximum amount of Pell grants first (based on number of people in your household) and your AGI (Adjusted Gross Income) compared to the FPL (Federal Poverty Line). If not eligible, your maximum Pell Grant amount will be subtracted by the SAI. Finally, you will still be considered for a minimum Pell Grant if no award is given. These other factors in the formula for aid are listed in no order but should be noted for your situation.

The student income protection allowance threshold was raised from $6,800 to $9,400.

• Businesses and farms that employ 100 or more employees will be considered an asset going forward

• Capital Gains from the sale of investments will be considered income on the FAFSA

• Child support received is now reported with assets NOT income

4. Student income from outside sources

Short answer: A student’s financial aid won’t be penalized for withdrawing 529 funds early.

Currently students must report gifts or distributions from a 529 owned by a non-parent (e.g. grandparents or other family members) or non-custodial parent if the student's parents are divorced. Due to the FAFSA’s prior income year rules, a student who needed access to those funds before Jan. 1 of their sophomore year of college would be penalized in the formula for the withdrawal. Now they are completely removed from the aid formula calculation.

5. New student allowances for the cost of attendance

Short answer: FAFSA will cover more day to day student expenses.

Although these are smaller changes, college students alike must not overlook these valuable new allowances that the FAFSA will allow students to claim for ancillary items. Not only is there a small allowance for personal expenses if a student works part-time but a personal computer purchase with no enrollment status requirement. You can even have an allowance for transportation between home, work, and school. More details can be found here.

Proactive financial aid resources to guide your family

For a current or future college student, utilize the free Student Aid Estimator.

If these changes make need-based options harder to attain, look for colleges that offer merit scholarships. This does not mean forgoing the FAFSA completely but intentionally seeking out Merit scholarships at specific institutions. This process, known as Early Action, is detailed in this article with a list of colleges that offer Merit Aid. We recommend starting this process early as many colleges recruit students as early as late spring of your child's junior year!

Finally, contact financial aid offices to see if they will be awarding institutional dollars based on the current formula not connected to the EFC/SAI numbers.

We can help with education planning

The FAFSA is changing for better or for worse and will affect how parents and students think about college for years to come. If it would be helpful to consult a team of credentialed advisors with expertise in college planning, schedule a call here.

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What recession?

As prognosticators assessed markets and the economy in the beginning of 2023, the expectation for many was a tumultuous year,  with a substantial likelihood of a recession. Now, nearly two-thirds of the way through the year, the S&P (Standard & Poor) 500 has surged by 18.73% through the end of August. Real GDP (Gross domestic product) has maintained steady growth, with quarterly increases of at least 2% since Q3 2022. Inflation, which began the year at a daunting 6.4%, has receded to 3.18%, still above The Fed's 2% long-term target but showing a marked improvement.

What changed given the gloomy expectations for 2023 at the start of the year? The biggest unknown was the impact of The Fed’s decision to continue raising interest rates. The expectation was that The Fed raising interest rates to cool inflation would cause an economic recession. We’ve even seen rising rates play a role in multiple banks failing earlier in 2023, but those events haven’t triggered any distress.

We’ll break down the top themes for why we’re seeing the markets and economy continue to power through.

Theme #1: Strong job market

Inflation has gone down, but GDP growth remains positive, and unemployment remains low. There are still 3 million more job openings than job seekers, and few were expecting The Fed to get this far on inflation without dipping the economy into a recession. Even experts have a difficult time accurately predicting where the markets and the economy are going.

Theme #2: ‘Soft landing’ of interest rate hikes

In contrast to the substantial interest rate hikes witnessed in 2022, the changes in 2023 have been modest. A significant contributor to the slowdown in interest rate hikes was the decline in inflation during the latter part of 2022, which has persisted into 2023. Consequently, The Fed didn’t need to enact as many rate increases, or do so as rapidly as they did in 2022.

Theme #3: Surprising growth from S&P 500 companies

The S&P 500’s rise has a couple of factors going for it. While 2022 saw a decline in earnings per share for S&P 500 companies, 2023 has witnessed earnings growth, with expectations that growth will continue. Analysts are feeling increasingly optimistic that companies will find a way to bolster earnings amidst a higher interest rate environment.

The other piece of the puzzle is the exceptional performance of the largest stocks within the S&P 500 this year. The S&P 500 is a market cap weighted index, meaning that each stock is weighted based on how large the company is. This means AAPL has a bigger weight than Home Depot, and AAPL being up 10% would increase the S&P 500 performance more than HD (Home Depot) being up 10%.

In 2023, returns have been concentrated in a few high-performing stocks. Put differently, only 28% of stocks in the S&P 500 have outperformed the index. This highlights the dominance of a handful of top performers in 2023. It’s worth noting 61% of stocks in the S&P 500 have achieved positive returns for the year, indicating favorable performance across the stock market.

Source: Data for this paragraph is based on using IVV (iShares Core S&P 500 ETF) holdings. Positions were all verified to be held 12/30/2022 and 8/24/2023 to ensure consistency of constituents. Average returns assumes equal weighting of the positions. Top 10 holdings are based on 8/24/2023 weighting: AAPL, MSFT, AMZN, NVDA, GOOGL, GOOG, META, BRK.B, TSLA, UNH. Jan-Aug performance data courtesy of YCharts as of 8/31/2023 market close.

Theme #4: Mid and small sized companies are not far behind

Many talk about the S&P 500 as though it represents the entire stock market. However the S&P 500 represents the largest companies in the US (typically $14.5 billion and greater), leaving out companies considered mid-sized and small.  The mid and small parts of the US markets have been lagging, still positive returns but not as high.

Source: All data courtesy of YCharts. Assumes S&P 500 for US Large, S&P 400 for Mid, S&P 600 for Small, and S&P 1500 for Total Market (blend for all). Uses Value & Growth versions of benchmarks respectively.

Predicting short-term MARKET outcomes continues to be difficult

Short-term value oriented investors may be frustrated to see their performance lagging the broad market. Alternatively, longer-term investors recall seeing a significant benefit in 2022 by experiencing less negative returns than the broad market or growth stocks. You are still positive from the start of 2022 to the end of August 2023. Growth and blend investors are still waiting to recover from the downturn. Trying to time when value or growth will outperform is not recommended. Find an investment style that suits your risk tolerance and financial plan, and be prepared to stick with it for the long haul despite periods of under or over performance.

The year 2023 so far serves as a compelling illustration of how stocks can still generate positive returns even in the face of grim expectations. It is also a great reminder of how difficult accurately predicting the economy or the markets is. The outlook for the equities market is rarely all sunshine and rainbows. Stock market volatility means that short-term corrections are always on the table. There are and always will be valid concerns that could lead to a downturn. If you are choosing a particular tilt in your investments, be prepared to stick with it over time. Long term, equities remain the best way to grow your savings. It is valuable to remember and reflect on the times when you anticipated poor returns but were pleasantly surprised by positive performance.

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What is the yield curve?

The yield curve refers to the current yields of US treasury bonds based upon time until maturity. It’s frequently depicted as a graph to help summarize the data. Typically, a yield curve is upward sloping. Short-term (ST) rates are lower, and long-term (LT) rates are higher.

Wall Street Journal, Bonds & Rates: Yield Curve, April 25, 2023

Reading the yield curve:

• A “steeper” or “steepening” of the yield curve means short-term (ST) rates are lower, and long-term (LT) rates are higher, resulting in a steeper line when comparing

• A “flatter” or “flattening” of the yield curve is when ST rates and LT rates are equivalent, or are getting closer to parity

• An “inverted” yield curve is when ST rates are higher than LT rates, like the current line in the snapshot above.

What determines the yield curve?

All rates on the yield curve are determined by the market. The Fed only controls the federal funds rate, which is only the rate banks lend to each other overnight. Because the market determines the shape of the yield curve, many look to the yield curve as a summary of overall investor sentiment to draw conclusions about expectations for the future. Some important market factors that influence the yield curve include:

• Liquidity (time horizon): The more time until a bond matures, the longer you have your money tied up. As a result, a longer time to maturity (and lower liquidity) bond tends to have a higher yield. This contributes to an upward sloping yield curve.

• Growth expectations: If there are higher growth expectations, you tend to see a steeper yield curve. This is because higher growth tends to lead to higher inflation, and so rates must be higher to achieve positive real returns.

• Demand: As more investors demand a bond, the price goes up. As bond prices go up, yields go down.

Why is the yield curve inverted, and why does that indicate a recession?

The yield curve is inverted because ST rates are higher than LT rates. This is largely due to The Fed raising interest rates to lower inflation. The Fed appears determined to reign in inflation, and has raised ST interest rates to slow down the economy enough to reduce inflation. This is putting upward pressure on ST rates. Many expect this approach to cause a recession, which would lower growth expectations, reducing LT interest rates. The result is the inverted yield curve we see today.

Why does this inversion indicate a recession?

In theory, the market is pricing treasuries so the returns over a given time period are the same, regardless of what you buy today. Let’s use an example to illustrate this.

Say you want to invest $10,000 in treasuries for 2 years, you can make two choices:

1. Choice #1: Buy a single 2 year treasury

   • Currently a ~4.2% yield, so you earn roughly 4.2% for 2 years.

2. Choice #2: Buy a 1 year treasury today, then a new 1 year treasury in 1 year:

   • Currently a ~4.7% yield, so you earn roughly 4.7% for 1 year.

   • After the first year, your treasury will mature, and you will have to purchase a new treasury at whatever the current rates are. The yield curve today is predicting 1 year rates will be at 3.7% in the following year.

   • Your overall return after averaging those rates for each year is 4.2% — the same as buying a 2 year treasury initially!

A lower rate in the future indicates lower growth expectations at that time. Growth expectations being lower (or negative) does not bode well for the health of the economy. The inverted yield curve also has a solid record of predicting recessions, but that doesn’t mean it’s perfect or guaranteed. The yield curve reflects the average sentiment of the markets, which indicates what expectations are. Sometimes expectations create a self-fulfilling prophecy situation, and sometimes expectations are flat out incorrect because of an unexpected shock, like the COVID-19 pandemic.

What does this mean for me and my portfolio?

Ultimately your portfolio should be allocated for the long term, and that should be positioned accordingly. While the inverted yield curve has been a strong predictor of recessions, the timing of that prediction and how significant it’s going to be are not consistent enough to provide an easy 5 step solution for everyone.

If you are positioned towards the more aggressive end of what you are comfortable with, consider reducing risk with some volatility expected on the horizon. Understand that regardless of the yield curve today, the long run expectation is growth and positive returns for the economy and equity markets.

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As financial planners, we constantly seek opportunities to steward our client’s assets. Protecting your identity is a critical aspect of this responsibility as many of our planning tools and custodian accounts can be accessed on any device at any time. In today’s digital age, identity theft is a growing concern. It has become easier for criminals to steal someone’s identity and wreak havoc on their financial and personal life. Fortunately, you can take steps to protect yourself from identity theft.

Here are 10 ways someone can protect their identity from getting stolen:

1. Create strong and unique passwords: One of the easiest ways to protect your identity is to use strong, unique passwords for all your accounts. A strong password includes a mix of uppercase and lowercase letters, numbers, and symbols. The longer the password, the better. Avoid using the same password for multiple accounts, as this makes it easier for hackers to access all your accounts if they guess one password. Our best advice is to try to come up with a “passphrase” instead of a password. For example, “#Cantwait4theWEEKEND!”  

2. Enable two-factor authentication: Two-factor authentication adds an extra layer of security to your accounts by requiring a code in addition to your password to log in. This code is usually sent to your phone or email, ensuring that only you can access your accounts even if your password is compromised. Do not provide this authentication code to anyone else.

3. Be cautious of phishing scams: Phishing scams are a common tactic used by identity thieves to trick people into giving away their personal information. Be cautious of unsolicited emails or text messages that ask for personal information or contain suspicious links. Always double-check the email sender or phone number to ensure it is legitimate.

4. Regularly monitor your credit report: Review your credit report for errors or fraudulent activity and report any unauthorized accounts or transactions to the credit bureaus and the affected creditors immediately.

5. Freeze your credit if you don’t need to tap into it: A credit freeze restricts access to your credit report, making it difficult for identity thieves to open new credit accounts in your name. Contact each of the three major credit bureaus (Equifax, Experian, and TransUnion) to request a freeze.

• Equifax: Call 800-349-9960 or go online.

• Experian: Go online to initiate, or for information, call 888‑397‑3742.

• TransUnion: Call 888-909-8872 or go online.

6. Shred sensitive documents: To prevent identity thieves from piecing together your personal information, shred sensitive documents such as credit card statements, bank statements, and tax documents.

7. Don’t give out sensitive Information: Don't give out personal, financial, or health-care information over the phone, mail, or the Internet unless you have a trusted relationship with the requestor and initiated the contact. Even with trusted contacts, it’s best to send secure information securely. Using online portals to upload information or password-protected files can be a way to protect your information.

8. Secure your devices: Keep your computer, smartphone, and other devices up-to-date with the latest security updates and anti-virus software to protect against malware and other threats. Require a passcode to access your phone or computer if they are idle for an extended period.

9. Be mindful of public Wi-Fi: Avoid using public Wi-Fi networks for sensitive tasks such as online banking, as these networks are often unsecured and vulnerable to hacking.

10. Limit your social media footprint: Be mindful of the personal information you share online, including on social media platforms. Consider adjusting your privacy settings to limit the amount of personal information visible to others. If you are a parent, be mindful of how much of your child’s personal information you share online. Personal information (birthdays, the street they grew up on, etc.) can make security questions and answers vulnerable to hacking in the future.

In today's digital age, protecting your identity is critical, and as financial planners, we encourage our clients to take proactive steps to safeguard their personal and financial information. If you believe that any of your logins have been compromised, our advisors and partners will work swiftly with you to protect your accounts.

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As a Charted Financial Analyst serving as the firm’s Director of Investments and Compliance, I oversee the construction and management of client portfolios. How we go about investing client capital involves evaluating a variety of factors that move the markets. Given the economic backdrop for 2022, I thought it would be helpful to address a few of the components impacting the economy and subsequent stock and bond market volatility.

Historical trends suggest the current high levels of inflation will not persist.

 Inflation is higher than it has been for decades, exceeding 7.5% in the March to October 2022 numbers, represented in the purple line below. The breakeven rate between a 5-year Treasury Inflation Protected Security (TIPS) and a standard Treasury is commonly used as a benchmark for what average inflation over the next five years is expected to be. The graph below shows this in orange below, hovering around 2.34%.

What is causing inflation?

There are broadly two types of inflation:

1. Demand-pull inflation occurs when there is too much demand for a limited supply of items (too much money chasing too few goods).

2. Cost-push inflation occurs when the costs of inputs for producers increase, and those costs are passed along to consumers (too few inputs to produce too many goods).

Both factors are helping push inflation higher. Government stimulus in response to COVID and global supply chains having to adjust in response to the pandemic have both had their part in increasing inflation, along with many other factors.

What brings inflation down?

Macroeconomic theory believes that inflation falls when an economy slows down. A slower economy usually means higher unemployment and less spending and investment. This means there isn’t too much demand-pull inflation occurring because higher unemployment means there are fewer wages chasing the goods produced. Higher unemployment also tends to lead to lower cost-push inflation because the cost of labor typically goes down when unemployment is high.

The Fed is still working on a soft landing.

Higher inflation is not healthy for an economy long term. Banks still want to make money even when inflation is high, so they lend at higher rates to ensure they still make a profit after accounting for inflation. Higher interest rates result in a higher cost of borrowing, making any investment (buying a house, going to college, launching a new business, building a new production facility, etc.) more expensive. Households and companies invest less, which means fewer productive and good investments happen, slowing down the overall economy.

Because high inflation is unhealthy for an economy, the Federal Reserve (aka “The Fed”, the US central bank) is raising interest rates. The Fed’s goal is to raise interest rates high enough to slow down the economy and bring down inflation. The concern is that The Fed will be too aggressive in raising interest rates and cause a sharp economic downturn. The hope is The Fed can execute a soft landing, slowing down the economy enough to reign in inflation but not slowing down so much to trigger a major recession.

The job market is still experiencing labor scarcity.

Currently, there are about 5 million more open jobs than people looking for a job. Unemployment is below 4%, near the historical lows we were experiencing pre-pandemic. Due to labor scarcity, employees are seeing their wages rise.

The overall economy is seeing consistent growth.

Gross Domestic Product (GDP) is the most used measure of the size of an economy. Real GDP (rGDP) accounts for inflation. The orange line is a “trendline” for real GDP, based on the average growth of rGDP from 2012 to 2017. As you can see, GDP is not far off from what would have been expected if the COVID downturn & recovery had never occurred. While the first half of 2022 had two-quarters of negative GDP growth (a common definition of a recession), Q3 2022 saw the economy grow.

Company earnings are still increasing despite downturns.

The following chart illustrates earnings growth compared to the S&P 500. The market tends is forward-looking, setting prices based on what is expected to happen. Current fears about inflation & The Fed triggering a downturn by raising interest rates too much too quickly are pushing the market down. Earnings reflect what companies earned in the previous three months. While there is a lot of anxiety about the state of the economy, companies are continuing to earn money and will continue to do so even in a downturn.

What does this mean for you and your portfolio?

In conclusion, there are contradictory messages. The economy quickly recovered from the global pandemic, and the workers are enjoying a solid labor market with wages rising. The positive economic news is contrasted with poor investor experience in the stock market. Concerns about high inflation and The Fed’s anticipated aggressive rate hikes to combat inflation have the market worrying about a recession. With all this happening, companies have continued to grow their earnings.

While there is conflicting information in the short term, we continue to anticipate long-term growth in the economy and stock market. Having a sound financial plan that accounts for downturns and uncertainties is crucial. Feel free to reach out if you have any questions about your plan or have had any changes in your financial situation.

All data courtesy of YCharts Nov 29, 2022.

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Inflation can lay waste to portfolios and wages, which is one of many reasons why inflation is concerning for laborers and investors alike. Some speculate that the rise in inflation is from supply chain congestion, resulting from labor shortage due to the Coronavirus pandemic. Others hypothesize that a flood of liquidity into the global economy, which stems from quantitative easing dating back to the financial crisis in 2007-2009, is the cause of rising prices. Regardless of the reason, the concern is that gains in wages and market appreciation are muted, or worse, erased, by an escalation in prices for goods and services.

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Inflation’s History

It has been three decades since we've seen inflation at current levels and even longer since inflation averaged double digits (several different times in the mid-70s to early 80s)[1]. Clients of our firm who remember the 1970s recall long gas lines, borrowing for a home purchase at 15%, and investing in treasury bonds at over 10%.

Consider this: in October of 1981, the 30-year mortgage rate was 18.45%[2]. As I type, that sort of rate seems almost unthinkable, yet it's true. To illustrate how it would impact the average homeowner or investor today, imagine a $500,000 home purchase with a 20% down payment. An individual would be financing $400,000 and be left with a $6,175 payment!

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How Does Inflation Work?

Inflation works in a similar way with food, gas, and other products and services we use regularly. Inflation can be viewed as a tax that leaves consumers with less to spend at the end of each month. With consumers facing higher prices, the dollars they spend must go to the staples such as food, housing, and gas—while potentially having less to spend on discretionary items such as travel and entertainment.

To combat inflation, the Federal Reserve (the Fed) will typically increase short-term borrowing costs on member banks—which in turn, trickles down to the consumer. Managing inflation is a primary objective of the Federal Reserve. The inflation target for the Federal Reserve is 2%. With both headline and core inflation trending well above those targets, aggressive rate increases are warranted. Surely the invasion of the Ukraine by Russia has complicated the Fed’s rate decision. My previous article “War and the Market: What Does History Teach Us?” discusses this topic further. Despite the concern over the war in Ukraine, the question is not if the Fed will raise rates. Instead, it’s a matter of how fast the Fed will hike rates and when they will stop.

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Our Recommendations

First, revisit your budget. See where you are seeing the biggest increases as some individuals are impacted far more than others. For example, my brother is a sports fisherman who is impacted much more by the price of fuel than I am with a five-mile commute to work. At the same time, a family of seven will feel food inflation much more than my parents, who have been empty nesters for almost 30 years. Secondly, once you have revised your budget, a conversation with your advisor can be warranted. For some who are living off a fixed income, the process will require pairing back or needing larger distributions from your portfolio. For others, it may prompt a change in your investment mix. While for many clients, the process may entail staying the course.

Investors whose investment horizon is long-term should continue to invest in a diversified, low-cost, equity-leaning portfolio. However, for investors who are either uneasy with market gyrations or have a more condensed investment timeline, multiple levers can be pulled to potentially position the portfolio to hold up well during inflationary times. Many experts agree that treasury bills and private real estate hold up well during inflation. [3],[4] It is also important to note that during inflation cycles, equities do well; however, volatility can increase, making maintaining a portfolio heavy on stocks problematic for investors whose emotions can get the best of them.

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Guidance for Those who are Worried

If you are prone to worry about your investments, there are several actions to consider. First, consider looking at your investments less often. This does not mean a “head in the sand” approach. Instead, if you are looking at your portfolio a few times per day, consider a few times per week. Or, if it’s weekly, consider checking in on your accounts monthly. Second, look at history for context surrounding the volatility. What you will find is that the market, on average, experiences a 14% intra-year drops since 1980. This may not provide you all the peace you want , but having perspective on what is normal can be helpful in curbing emotions. To further combat mixing emotions with investments, read “How to Avoid the Investing Cycle of Emotions” by our own Will Kellar, CFP®. Finally, if the volatility is cause for sleepless nights, you may be someone that needs to take less risk, meaning a conversation with your advisor is warranted.

Because the course of this inflationary cycle is unknown, it is essential for all investors to track their spending to determine what impact inflation has had on budgets. For some, there is plenty of discretionary capital to absorb the increase prices; however, for others, it may be necessary to tighten the belt and prioritize essential spending, to minimize the impact of elevated costs.

[1] U.S. Inflation Calculator

[2] History of Mortgage Interest Rates

[3] Fama, E. F., & Schwert, G. W. (1977). Asset returns and inflation. Journal of financial economics, 5(2), 115-146.

[4] Crawford, G., Liew, J. K. S., & Marks, A. (2013). Investing Under Inflation Risk. The Journal of Portfolio Management, 39(3), 123-135.

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If you have feedback for us, have questions, or would like to hear more on other topics we’ve not already covered, please email us directly at hi@humaninvesting.com. We cherish the emails and questions and look forward to connecting with you soon.

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Did you Make Over $125,000 Individually or over $200,000 as a Married Couple?

There are two new local personal income taxes that became effective for the 2021 tax year. These two taxes, explained below, are specifically for single filers with Oregon taxable income above $125,000 and married jointly filers with Oregon taxable income above $200,000.

These two programs are local taxes, not state taxes. This means that the tax payments go directly to The City of Portland and require an additional filing. We expect high-income earners in the Portland-metro area to have at least three tax returns for 2021: US Individual Income Tax Return, Oregon Income Tax Return and City of Portland.

Like your federal and Oregon state tax return, these local tax returns are also due by Monday, April 18.

Local tax #1: Preschool for All (PFA) Personal Income Tax

In November 2020 Multnomah County voters passed The Preschool For All Program which will provide tuition-free preschool for children that meet the program criteria.

• This local tax is funded by a 1.5% marginal personal income tax on taxable income above $125,000 for single filers and $200,000 for those married filing jointly.

• This local tax is also funded by an additional 1.5% tax is imposed on taxable income over $250,000 for single filers and $400,000 for those married filing jointly

Local tax #2: Portland Metro Tax

In May 2020, Portland-area voters approved Measure 26-210 which will provide homelessness services like shelter, advocacy, and mental health resources.

• This local tax is funded by a 1% marginal personal income tax on taxable income above $125,000 for individuals and $200,000 for those married filing jointly.

• This local tax is also funded by a 1% business income tax on net income for businesses with gross receipts above $5 million.

• The Portland Metro area includes residents of Multnomah County, Clackamas County, and Washington County. For a full reference guide of the Metro jurisdiction use this online tool.

How can I Find my 2021 Taxable Income?

Taxes are complicated. Remember that your income (like your salary) is not the same as your taxable income. For example, you could earn a salary of $140,000 a year but have less than $140,000 of taxable income because of pre-tax retirement account contributions and taking the standard deduction or itemized deductions.

The easiest way to confirm your 2021 Oregon taxable income is to complete an Oregon Income Tax Return. Your taxable income is included on line 19 of your Form Oregon 1040.

If you are a single filer and your Oregon taxable income (on Line 19 on your 2021 Form OR-40) is greater than $125,000 or if you are a married jointly filer and your Oregon taxable income is greater than $200,000 then you likely need to pay your taxes by April 18, 2021.

FINDING YOUR TAXABLE INCOME IN TURBOTAX

1. Login and find the Documents tab.

2. Download your tax PDF. Scroll to the bottom of the PDF for the Oregon return.  

3. Find your 2021 Form OR-40. Line 19 includes your total taxable income.

examples of Calculating your local taxes owed

Preschool For All Tax: $0 because her income is below the $125,000 threshold for individual taxpayers.

Portland Metro Tax: $0 because her income is below the $125,000 threshold for individual taxpayers.

Preschool For All Tax: $6,000.
Tier 1: $400,000 - $200,000 = $200,000 of taxable income. $200,000 x 1.5% = $3,000
Tier 2: Then, $500,000 - $400,000 = $100,000 of additional taxable income. $100,000 x 3% = $3,000

Portland Metro Tax: $3,000.
$500,000 - $200,000 = $300,000 of taxable income. $300,000 x 1% = $3,000

Preschool for All Tax: $0 because they are not a Multnomah County resident.

Portland Metro Tax: $350.
$160,000 - $125,000 = $35,000 of taxable income above the threshold. $35,000 x 1% = $350

How Can I Pay for this Tax?

If you hire a CPA to prepare your individual tax returns, we recommend confirming that they will also file your City of Portland taxes for you. 

If you use an online tax software like turbotax, you will have to visit the Pro.Portland.gov website to submit your tax payments in a separate return. If you are a Multnomah County resident, this process will feel similar to paying your $35 Arts Tax.

What if my Taxable Income is Below the Limits for the PFA and Metro Tax?

You do not need to file anything to the city of Portland if your taxable income is below the limits for both local taxes in 2021. However, if you are a Multnomah County resident then don’t forget to pay your Multnomah County Art Tax for 2021. You can pay for it here: Portland Arts Tax Online Payment.

If you have more questions about the new local taxes, or would like to speak to a financial professional please reach out to us at hi@humaninvesting.com or 503-905-3100.

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With Russia’s invasion of Ukraine this week, many are wondering how a conflict in Europe will influence their own finances. In addressing this headline for our firm, please understand that the loss of life and the disruption of peace weighs heavy on me and our team. While considering investor concerns, our goal is to provide a point of view which I feel we are uniquely positioned to share amid war as a financial management firm.

Markets trade on future expectations. For example, if the market expects new jobs or a strong economy, then people and businesses adjust their decisions today, based on what they believe is coming. Remember how the market crashed when COVID-19 first hit the United States, but bounced back a month later? That’s because people were making choices based on expectations, not necessarily reality.[1] Because war follows a circuitous route, forecasts are less clear. Researchers accurately note that “the impact of conflict on human lives, economic development, and the environment is devastating.”[2]

Previous Wars and Invasions Show That Market Reactions can Range Wildly.

For example, in 1990, Iraq invaded Kuwait and immediately the global stock markets declined.[3] In the three days that followed the Iraqi attack on Kuwait, the Dow Jones Index slid over 6%; yet in the first four weeks of Operation Desert Storm, the Dow gained 17%.[4] Additionally, the European Stock market responded positively to the second conflict with Iraq in early 2000. Stock market history has shown divergent reactions to war.

Surely, the economy of Ukraine will be devastated, but no one knows what the financial repercussions from this Eastern Europe conflict are. For example, when the news broke about Russia’s invasion, the European markets went down around 4%, but the US market went up by about 1.5% at the end of the day. We simply can’t predict the future, and the market changes moment-to-moment, day-to-day. The only real certainty is that volatility will resume as individuals and institutions place their bets on future predictions, and because of this, our client financial plans and asset mixes navigate all types of situations.

Finding your Footing in Uncertainty

Market related volatility is an un-welcomed but natural part of the investing journey, so our client portfolios at Human Investing are constructed with a plan and risk tolerance in mind. For example, a client that has cash needs to support their day-to-day expenses (such as a retiree) will often have a portfolio with equities that pay dividends, bonds that pay interest, and ample cash to cover upcoming obligations. On the other hand, investors who rely on equities should understand that stock volatility is the price we pay for the expected premium we receive in the long run over cash and bonds.

Although the headlines of “war” and “invasion” cause anxiety, the questions investors should ask are, “How is my plan working out?” and “Despite the market volatility, am I still on track?” Keep in mind that although the average annualized return of the S&P 500 since 1926 is approximately 10.5%, market swings may increase considerably. [5]  Investors should think about their financial plan, investment goals, timelines, and overall diversification to determine how well they are prepared to manage the ups and downs. Adjustments can always be made to ease the concern in the short term, but for most of our clients, their financial plan and current asset allocation take into account market downturns, caused by a myriad of events, including invasions and war.  Through it all, we at Human Investing are present in all of life’s ups and downs as we faithfully serve the financial pursuits of all people.

[1] Frazier, L. (2021, February 11). The coronavirus crash of 2020, and the investing lesson it taught us, Forbes. The Coronavirus Crash Of 2020, And The Investing Lesson It Taught Us

[2] Cranna, M. (1994). The true cost of conflict. New York: New Press. The true cost of conflict / | Colorado Christian University

[3] Richter, P. (1990, August 3). Markets react to Kuwait crisis: Stocks: Invasion rocks market; dow slides 34.66, Los Angeles Times. MARKETS REACT TO KUWAIT CRISIS : Stocks : Invasion Rocks Market; Dow Slides

[4] Schneider, G., & Troeger, V. E. (2006). War and the world economy: Stock market reactions to international conflicts. Journal of conflict resolution, 50(5), 623-645. War and the World Economy: Stock Market Reactions to International Conflicts

[5] Maverick, J. B. (2022, January 13). What is the average annual return for the S&P 500? Investopedia. S&P 500 Average Return: Overview, History, and Factors

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Welcome to fall! Before we race to the pumpkin patch, let’s look back on July, August and September. We selected 5 different visuals from the past quarter to share with you.

1: The S&P 500 Reaches an All-time High

On September 2, 2021, the S&P 500 closed at an all-time high (see chart). While this is a record-breaking statistic, the S&P 500 has also experienced more than 50 all-time highs in 2021. Prior to this year, there are only six other calendar years with at least 50 record closes (2017, 2014, and 1995 are the most recent years).

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As a result of these market highs, we have noticed heightened concerns about a looming market crash. Because what goes up, must come down?? The two most common concerns we hear are:

1. “I know the market is at an all-time high. I want to sell my investments today and reinvest these dollars when the market crashes in the coming months”. See chart 2 for our typical response.

2. “I know the market is going to crash. I want to move all my money into something safe like cash or bonds. What do you think I should do?”

If you are someone that is worrying about your investments (maybe it’s something entirely different from the two concerns listed above), please reach out to our team so we can listen to your concerns and build an investment strategy for you going forward. To be frank, the timeline for spending 401(k) dollars impacts the advice we give. For example, we would give different advice to someone planning to spend their 401(k) savings soon than to someone in their mid-forties with no intentions of spending their 401(k) soon.

2: What About This Looming Market Crash?

If you have setup a 401(k) account, then you are investing your dollars every single pay period. This phenomenon is called dollar-cost averaging and it works really well for most retirement accounts. If you have a 401(k) account, we recommend leaning into dollar-cost averaging, setting up annual account rebalancing, and assessing your account strategy periodically. Of course, this strategy is not one-size-fits-all. Some investors prefer to intervene with their investments if they are predicting an upcoming market crash.

That being said, we recently found this article by Nick Maggiulli that compares gradually investing a consistent dollar amount (like per paycheck 401(k) contributions) to saving dollars up to buy a market dip. Please take the time to read the whole article, but if you want the cliff notes here you are:

• The article points out that stockpiling cash in anticipation of a market crash is an unlikely strategy to win out in the long run.

• Trying to buy the dip usually fails because large dips are rare. As a result, the strategy turns into stockpiling cash which is not a good idea for the long-term.

• If you do want to try and buy the dip, think about getting your cash invested in the stock market as soon as possible.

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For some help interpreting this chart, here is the text directly from Nick Maggulii’s blog post. “This chart shows that there is roughly a one in four chance of beating DCA when using a Buy the Dip strategy with a 10%-20% dip threshold. If you were to use a 50% dip threshold, the chance of outperforming DCA increases to nearly 40%. But this doesn’t come without a cost. Because while you are more likely to outperform DCA when using a bigger dip threshold, you also underperform by more (on average) as well.”

3: Monthly Child Tax Payments

July 2021 was the beginning of the monthly child tax credit payment for parents. Did you see our 20-minute webinar about the child tax credit, why it matters, and some financial planning considerations for parents?

Flash-forward a few months, and we have found a study of 1,514 American parents who received the monthly child tax credit payments. As you can see, most parents have saved their payments for emergencies which is a disciplined usage of the excess cash.

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4: Vanguard Announces Lower Fees for Target Retirement Funds

In late August, Vanguard announced they are lowering the expense ratio (the cost) of their target-date funds by February 2022. We believe this is good news for all investors using Vanguard target retirement funds!

Vanguard will lower the expense ratio to 8 basis points meanwhile they are committed to maintaining the same glidepath methodology and asset allocation.

To articulate the cost savings, we assembled a table showing the potential impact for someone invested in a Vanguard target retirement fund with the updated expense ratio. For someone with $100,000 in a Vanguard target retirement fund, this lowered expense ratio means immediate annual savings. Just to be clear, the $90 vs $80 are annual fees which add up to be meaningful cost savings for you over a long period of time. Cheers!

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5: Be Careful who you Get Advice From

How many self-proclaimed market savants are sharing their opinions with the world? So many! Be careful who you listen to. We couldn’t help but include some humor in this post. Feel free to relish in the ridiculousness of this chart.

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That concludes our Charts of Q3 2021 post. We will be assembling the next Charts of the Quarter post before we know it. Take care! — Your Human Investing Team

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In a recent interview Jason Zweig, a personal finance columnist for the WSJ, had a quote that resonated with me.   

  "Emotional discipline is the single hardest thing about the investment game."   

After accumulating over 30 years of writing and thinking about investing and personal finance, Jason points to emotion (not market valuations, stock picking, or market corrections) as the most difficult part of investing.  As financial advisors, we witness the struggle of emotional discipline firsthand. Recent news (and noise) around tech stocks, housing prices, federal spending, cryptocurrencies, inflation, and interest rates have made it more difficult for investors to maintain this discipline.  

are you an investor facing FOMO or FOBI?  

This lack of emotional discipline manifests itself typically in one of two ways:   

1. Fear of Missing Out (FOMO) in the market. If you are 15 years old, FOMO is seeing your friends doing something without you on social media. If you are an investor, FOMO is the internal dialogue of “I see my neighbor making money on ____, I need to buy ___.” Someone who has FOMO tends to follow the crowds. FOMO can lead an investor to think their rate of return is a benchmark for their success rather than achieving a return needed for a successful financial plan.

2. Fear of Being In (FOBI) the market. FOBI is the internal dialogue of “I have seen how this story ends. I need to sell ____.” Someone who has FOBI likely listens to news sources who make a profit off pessimistic news. Note: It is easy to push the sell button, it is always harder to get back in.  

FOMO and FOBI may seem different, however, both are ultimately trying to guess where the market will go next and are speculative in nature. Let 2020 be a great reminder that it’s difficult to predict how the market or a particular investment will do year to year.  

Periodic Table of Investment Returns from the last 20 years

One of my favorite charts to illustrate the difficulty to predict short-term performance is "The Periodic Table of Investment Returns". This graph ranks the annual returns of popular asset classes from best to worst over the last 20 years.   

Source: Blackrock; Past performance is no guarantee of future results. The information provided is for illustrative purposes and is not meant to represent the performance of any particular investment. Assumes reinvestment of all distributions. It is not possible to directly invest in an index. Diversification does not guarantee a profit or protect against loss.

An investor experiencing FOMO is likely paying attention to the top row, the best-returning asset classes over the last 20 years. This investor is likely trying to guess what will be the highest performing asset class in the coming year.  

Meanwhile, an investor experiencing FOBI is likely paying closer attention to the bottom rows, with a specific focus on larger market selloffs like 2001, 2002, and 2008. A FOBI investor is worried about being invested in the wrong asset class and will try to avoid the worst-performing asset class in the coming year.  

The Periodic Table of Investment Returns reminds me of three investing truths:   

1. It can be dangerous to try and guess what is next. Consider US small-cap stocks (Sm Cap – in light green), which had the highest average annual return over the 20 years. While small-cap stocks were the best performer they also showed the widest variance in outcomes. Guessing right in 2003 would have provided a positive return of 47.3%. Guessing wrong in 2008 would have provided a negative return of 33.8%. 

2. Past performance is not an indicator of future returns. Making investment decisions based on recent performance (e.g., looking at 1, 3, and 5-year returns) can be detrimental to an investment portfolio.  International’s performance as a prime example (Int’l – in yellow), over the five years from 2003-2007 international was the best performing asset class by a long shot. International seemed like the sure thing. Unfortunately, the investors who followed international’s high returns were greeted with a brutal 43% selloff in 2008.   

3. Portfolio diversification is the answer to combating FOMO and FOBI – See “Div portfolio” in purple along the middle rows.  Diversification is an investment strategy that aims to maximize a level of return for the risk desired. Diversification accomplishes this by strategically spreading money across different types of investments.   

 A diversified portfolio helps investors maintain emotional discipline. Diversification can avoid the fear of missing out on the next hot investment. Owning more of the market will naturally provide more opportunities to not miss out on the growth of specific sectors or individual investments. Diversification can also temper being fearful of being in the market and owning the next big loser. Diversification disperses your dollars across many asset classes, which means if one company is a dud it will not sink the ship.  

If you struggle with emotional discipline when investing, congratulations you are a human. If helpful, please use The Periodic Table of Investment Returns as a great reminder that emotional discipline is difficult. Putting a plan in place along with proper diversification can help investors make smart long-term decisions.

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