Update on the Economy and Investment Markets 2-4-23

Welcome to the Stearns Financial Fireside Chat, Frequently Asked Questions Edition.

SFG in the News

IBM TV asks Dennis Stearns to provide a 2023 Economic Update

Dennis Stearns was asked to present an economic and investment market update to a worldwide audience on IBM TV last week. His main points were the ones discussed at SFG’s recent economic updates (and outlined in the last Chat), including the more favorable economic and inflation data of late. Dennis discussed the amazing growth of income in the U.S. (Gross Domestic Income) that helps lessen the impact of an economic slow-down. And overall job growth remains robust despite some sectors of the economy slowing down.

Interesting to note that Chairman Powell of the U.S. Federal Reserve used the word “dis-inflation” (meaning falling inflation) 15 times in his press conference last week. Even though the overall inflation news lately is “encouraging,” he still believes a few areas of inflation may be stubborn in coming down meaningfully in 2023. And he cited the same tight energy market and China reopening (discussed in our last Chat) as a reason gas prices at the pump may move back up later this year.

Corporate earnings and forecasts coming in during the last two weeks have provided a mixed bag of results, and still have the potential to keep stocks volatile. 

In the IBM TV interview, Dennis affirmed our belief that alternative assets (outside of bonds and stocks) continue to be good diversifiers, although a few flavors may have more modest forward-looking returns than they’ve had over the past five years. Fortunately, SFG has access to a broader cross section of alternatives than we’ve had in the past and continue to believe they add value when appropriately integrated within a well-diversified, high-quality portfolio.

Frequently Asked Questions

Q: How dangerous is the high U.S. federal debt of over $30 trillion now that interest rates are higher?

A: As a result of rapid interest rate hikes by the Fed, the nation’s debt has become a larger concern than it has been over the past 5-10 years.  As a percentage of the U.S. economy, the nation’s debt is now concerningly above 100%. While Japan has survived and thrived with a 200% federal debt level for over a decade, rising rates (which haven’t been an issue in Japan) create a greater cause for concern. This is due to the fact that higher interest rates in the U.S., while good for savers, mean a higher percentage of our tax dollars go to pay interest, potentially creating an economic drag.

As the chart above indicates, a whopping 50% of U.S. debt is set to mature in just the next three years, meaning a refinancing at higher rates will be required. Fortunately, as a percentage of tax revenue, the annual cost of the debt is still not at record levels.

Dave Walker, former Comptroller General of the United States (1998 to 2008), has been in constant contact with Congressional leaders about the federal deficit and believes the government’s ability to effectively intervene during a future crises requiring debt intervention has been eroded. In a recent conversation with Dennis Stearns, Dave made clear Congress needs to get fiscally responsible … and in a hurry. Sadly, and in true vintage form, it appears to take a crisis to get Congress’ attention. A registered Independent, Dave had multiple Presidential appointments from both political parties, achieving unanimous Senate confirmation each time. His most recent book (released in 2020) is entitled America in 2040: Still a Superpower (A Pathway to Success) and makes for an interesting read.

Q: As a young professional making a decent income, I would prefer to buy a home rather than rent. I’ve heard home prices have softened even as mortgage rates have risen. Do you think home values have bottomed out?

A: Month-over-month existing home sales prices continued their downward trend in December and are roughly 11% lower than their record high of $413,800 in June. Experts we talk to in the home industry believe home prices declines have leveled out in higher growth areas, due primarily to the limited supply of new homes. However, slower growth areas may see home prices continue to drop in 2023.

Mortgage rates have also dropped from 7%+ levels to around 6% for those with the strongest credit scores. It seems unlikely they will drop to 5% or lower unless the U.S. experiences a more painful recession than what is currently predicted.

Overall, we in the U.S. still have a housing supply shortage. New home construction fell again in December, adding to the longstanding inventory problem. Further, we learned this week in earnings calls from homebuilders that buyers are resurfacing now that mortgage rates have stabilized, indicating that at least some buyers have determined they can afford a 6% mortgage interest rate versus continuing to rent. The American dream of home ownership continues to be attractive for about half of the very large Millennial group despite data in recent years that young people are renting longer while delaying family formation.

Ongoing demand along with tight inventory have kept prices from substantially dropping off, keeping homes still unaffordable for many, especially first-time homebuyers.

SFG’s Take: It’s unlikely we will see bargain home prices in many geographic areas around the country. Therefore, the best strategy toward home ownership is to figure out what is comfortably affordable, consider all the financing options and talk to your financial advisor if you need a sounding board for how much to stretch. If you are considering an older home, make sure the inspections are done well and consider that more things may break in the near future. Leave some margin of safety in your budget for these hidden and often unpredictable costs.

Q: Our bank is still paying us less than 1% on our cash balances. What are our options?

A: We have many more options now that interest rates are higher. Many of our money market funds are currently yielding 4 to 4.5% – and we can get close to 4.7% on 1-year U.S. treasury notes (as of 2/2/23), still the safest investment despite the looming debt ceiling crisis. Interest earned from U.S. treasury securities is also generally exempt from state and local taxes, making them that much more attractive.

Cash within our managed portfolios already incorporate these higher-yielding vehicles. Cash held within client working capital accounts can also be invested in higher-yielding short-term instruments, such as money market at no charge to our clients. If you have excess cash scattered at various banks, you can consider moving these assets to a working capital account earning nearly 4.5%, with 24-hour liquidity. For further information, please contact your SFG advisor.

Q: Is it still a good time to sell my business given the current economic uncertainty and rising financing costs for potential buyers?

A: The answer is “it depends.”  Sadly, we’ve recently seen several deals fall through either because the buyer got cold feet due to economic uncertainty (fear of recession) or because higher borrowing costs made the deal less attractive.

Fortunately, we at Stearns have unique insight into such transactions given our interaction with business owners as a result of our work with business owners and expanding Business Owner Services (BOS).  Generally, what we have learned is that if the parties have gone through a rigorous process of assessing fit and synergies, the current economic environment may have little impact on transaction completion.

SFG’s BOS unit prefers to work with business clients for at least three years prior to sale, giving adequate time to ensure the eight key areas of the business’ “moat” are robust. This generally helps enhance the sale value as well as the terms of sale. We can also do more robust income tax planning with more advance preparation. However, when an offer to buy suddenly appears, we often get called in at the last minute to join a business advisory team for both exit and personal planning advice.

SFG’s personal financial planning services can help our business owner clients determine what they need out of the business to achieve financial security. And determine what won’t work in a business sale. It’s a good idea for any business owner to gather at least three potential qualified buyers. This way, if one becomes skittish, the others will be ready and willing to follow through. It’s also true that when the lead suitor for your business knows you have other interested partners, they may be less likely to get cold feet.

Summary

Many factors still indicate a slower growth scenario for the U.S. and global economy, but some key areas have seen recent improvement. We still have mixed data on whether a U.S. recession is likely in 2023, but it is increasingly likely that any recession, if present, will be mild. Certain sectors of the economy, like housing, could feel greater economic downside pressure.

SFG believes 2023 will be markedly different from 2022 in terms of investment performance. While we expect positive returns in most asset classes (contrary to last year), we believe some areas will experience only modest growth.

Wildcard risks (low probability, high possible impact) discussed in this and previous Chats remain and suggest some caution. Included among these risks are Putin’s future actions.

SFG is balancing numerous opportunities and threats in portfolios, customized to our clients’ unique circumstances.

In growth portfolios, we are leaning into a variety of short- and intermediate-term asset classes and trends we believe have favorable forward-looking risk/reward relationships.

In more conservative growth and income portfolios, we continue to maintain good diversification while striving for positive real returns over inflation.

Our “Sailing in Uncharted Waters” investing approach can be summed up by six themes:

• Diversification with a balance of offensive and defensive measures, depending on the desired risk tolerance of our clients,
• Underweighting, or avoiding areas of higher future concern,
• A focus on higher-quality investment themes,
• Identifying and implementing buying opportunities that may be appropriate for more growth-oriented portfolios,
• A more defensive stance using different portfolio tools for more conservative growth and income portfolios, and,
• Utilizing select alternatives to traditional bonds and stocks.

~ Dax, Dennis, Glenn, Jason, John and PJ
(The SFG Investment Committee)