Winter 2023 Newsletter

Happy New Year!

We hope everyone had a wonderful, healthy, holiday season with your loved ones. There’s always something about turning the calendar to the New Year that brings excitement and a fresh start. Or for us in Minnesota, a lot of fresh snow! Great for winter activities, not so great for driving. The parking lot at our office looks like a ski hill without the trail lifts. Hopefully it melts by…June.

2022 Postmortem

There’s no way to sugarcoat it, 2022 was a difficult year for investors. The Dow Jones Industrial Average and S&P 500 peaked as the year the began and ended the year down 8.8% and 19.4% respectively with the tech heavy NASDAQ losing 33.1%.

Russia’s invasion of Ukraine exacerbated inflation by temporarily sending oil prices higher and lifting commodities such as wheat. The Fed’s response to stubbornly high inflation prompted the fastest series of rate hikes since 1980, according to data from the St. Louis Federal Reserve. Put another way, the favorable economic fundamentals we were treated to in the 2010s - low interest rates, low inflation, and modest economic growth shifted dramatically last year. The economy expanded, but the interest rate and inflation environment overwhelmed any tailwinds from economic and profit growth.

Inflation is the root of much of the problems. A year ago, the Fed belatedly recognized that 2021’s surging inflation wasn’t simply “transitory,” its word of choice at the time.

The SECURE Act 2.0

Tucked away in the fiscal 2023 spending bill Congress passed at year-end, included SECURE Act 2.0 (“2.0”), the governments second iteration on improvements to the retirement system. A rarity in Washington these days, 2.0 enjoyed widespread bipartisan support. Some highlights:

• Pushed back the starting age for Required Minimum Distributions (RMD's)
• Increased catch-up contribution amounts for retirement accounts
• Tax-free rollovers from 529 accounts to ROTH IRAs
• New rules for accessing retirement funds during times of need

The Cracked Ball (reboot!)

Longer-term clients may remember “The Cracked Ball”, our prognostication on where the markets may be going and why. With the outlook particularly murky, and the dreaded R word (recession) front and center, it seemed appropriate to bring back The Cracked Ball. Along with the New Year brings new forecasts, predictions, and top 10 lists from everywhere and everyone. Most will be wrong, and like milk, won’t age well. But nonetheless, make for good headlines. 

So where are we going from here? Two quotes stand out as we peer into our Cracked Ball.

Be aware that the market does not turn when it sees the light at the end of the tunnel.  It turns when all looks black, but just a shade less black than the day before.   - Jeremy Grantham

There is nothing new in the world except the history you do not know.  - President Harry Truman

Given the quirks of a formal declaration of a recession, we could be in one now and it’ll be months before the National Bureau of Economic Research (NBER) makes it official. But what history has shown, of the 11 US cycles since 1950, is recessions have ranged from two months to 18 months, with the average lasting about 10 months. 

While the average expansion has lasted 69 months! Let’s reiterate that in a different way, the average economic expansion has historically been almost 7X longer than the average recession.

What’s more, stock markets usually begin to recover before a recession ends. If history is a guide, the equity markets could rebound about six months before the economy does. The strongest gains have often occurred, just a shade less black than the day before, immediately after a bottom. The average bull market duration is 67 months vs. average bear market of 13 months (that’s over 5X longer). While it doesn’t dull the pain of the average 33% bear market decline; the average 265% bull market gain is what drives successful long-term investors.

Fixed income was especially painful in 2022; the Bloomberg US Agg Index lost 13%. What typically acted as a ballast to a diversified portfolio and zig when equities zag, suffered mightily as the Fed aggressively raised interest rates to fight inflation. The good news…INCOME is back in fixed income. Yields, which rise when bond prices fall, have soared across sectors. Bond managers are usually a mundane group, but they are excited by the yields and opportunities after a challenging 2022. And like equities, there will likely be an inflection point, where being early will likely payoff more than being late.  Fixed income investors have historically been rewarded investing prior to a final rate hike. Purchasing bonds for a year starting six months prior to the last Fed rate hike in each of those cycles, illustrated on the right, would have returned a range of 3.3% to 10.2% in the first 12 months. Looking longer term, that year long investment would have provided a five-year annualized total return from 5.9% to 15.6%.         

Municipal bonds, usually a sleepy portion of the bond market, had its worst year since 1981 dropping 13%. If it wasn’t for a yearend rally adding nearly 5%, 2022 was on track to be the worst municipal bond market ever. As bond prices go down, yields go up and muni bond yields reached levels not seen in 15 years. For long-term investors, this could be an attractive entry point into municipal bonds. Muni bond interest payments are typically exempt from federal income taxes; and in some instances, state income taxes, making the current tax equivalent yields even more attractive.

Final factoid…since 1928, the S&P 500 Index has fallen for two straight years only four times: The Great Depression, World War II, the oil crisis of the 1970’s and the burst of the dot-com bubble, according to Bloomberg. Will it happen a fifth time this year? The Cracked Ball can’t say. Ultimately, we must control what we can control. We can’t control the stock market, the economy, or events overseas. But we can control your financial plan. 

It’s not set in stone, we need to adjust as life unfolds. If you’ve had changes, let’s talk.

Thank you for being our clients, it is our privilege.

Personal Side

The views and opinions expressed are based on current economic and market conditions and are subject to change. Forward-looking statements that are based on current market and economic conditions and assumptions, and involve uncertainties that could cause actual results, performance or events to substantially differ from those expressed or implied. Indexes referenced are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results.