Updates on the Economy and Investment Markets 1-29-22

Welcome to the Stearns Financial Fireside Chat.

The downturn in global equity markets persisted for the fourth week in a row, fulfilling expectations that 2022 will be a year of increased volatility.  In the U.S., a shift into value stocks by skittish investors resulted in a significant decline in growth stocks, especially big tech which fell below the “normal” 10% correction range. Outside the U.S., stocks also lost ground, but fared better than their U.S. counterparts.

Bipartisan anti-trust discussion in Congress, rising interest rates and concern regarding Federal Reserve actions in 2022 were largely to blame for the downturn. Federal Reserve Chair Powell continues to suggest patience with his plan for tapering government bond purchases and raising interest rates, however, the Fed’s more-aggressive tone in December has caused investors to grow leery of a potential misstep in the timing or magnitude of contractionary measures.

It is worth noting that the Volatility Index (VIX) inverted last week – a historical signal that equity markets may be near a bottom.  All this while U.S. earnings season is off to another good, but not great, start given underperformance by several big-name companies.  Even so, current forecasts call for 25% or more year-over-year earnings growth for the S&P 500 for the fourth consecutive quarter.  This may surprise some, given how negatively markets have reacted to higher supply chain costs and wage inflation, but we continue to expect outperformance by companies with strong fundamentals and enough pricing power to defend and expand margins in spite of higher inflation.

Geo-political wildcards are numerous, with a showdown between Russia and NATO increasingly likely. Our sources suggest Putin is a shrewd judge of risks versus rewards, and is likely not going to test NATO’s resolve in a traditional invasion. The non-traditional scenarios are complex, as unfortunately, European leaders have made several poorly calculated energy decisions in recent years, allowing Russia to gain a key bargaining chip with their new natural gas pipeline to Europe. 

Tensions between China and the U.S. also remain just below a boil. We would like to believe we are lessening our supply chain dependence on China.  As recently outlined in our SFG annual economic update, we are, but not a brisk pace as some major U.S. companies have increased their reliance on Chinese manufacturing. Four key global bottlenecks that heavily involve China include: 1) product, 2) transport, 3) labor, and 4) energy. Pre-omicron, the first of these looked to be easing (e.g., supplier delivery time improving). However, China’s zero-tolerance policy around COVID could create more shocks in the supply of products. We continue to watch future Chinese manufacturing data, which should give us some indication on whether there will be another shock in 2022.

Our 2022 Economic Update and Investment Forecast dove deeper into these and other issues. Moderated by Haleh Moddasser, CPA, the event featured investment committee members John Thomas, CFP, CFA; PJ Williams, CFA; and Dennis Stearns, CFP. 

Here are the key takeaways:

1. The U.S. and many overseas economies will perform better than average in the next year as a result of pent-up demand and high consumer cash and credit available for spending. The pandemic will likely turn into a less onerous endemic – in epidemiology, an infection is said to be endemic in a population when that infection is constantly maintained at a baseline level in a geographic area with less transmission between geographic regions.
2. Job turmoil will continue for employers – SFG is working on a special report for our clients called the Great Resignation. Stay tuned for its upcoming release.
3. Federal Reserve policy changes are creating concerns, but the proposed interest rate increases are still very modest by historical standards.
4. There are numerous headwinds and tailwinds for U.S. stocks in 2022. The recent correction, coupled with strong earnings growth projections, lowered valuations such that many stocks are now hovering closer to fair value.
5. High quality international companies are on sale and have interesting prospects going forward.
6. Alternative assets in real assets, private lending and real estate continue to have good potential return over inflation and good diversification benefits.
7. Low probability, but potentially highly impactful negative wildcards remain abundant. We continue to monitor closely and have contingency plans in place based on our scenario planning.
8. Longer term issues are still disconcerting, including the elevated level of fiscal debt, but don’t appear to be a strong danger near term.

CLICK HERE to view a recording of our 2022 Economic Update and Investment Forecast.

SFG’s Take: We believe the U.S. and global economy are well positioned for growth in the next few years. 2022 will be a good year for your portfolio to be diversified, given risks in individual asset classes. There are many headwinds and tailwinds to corporate earnings and stock prices, with continuing volatility very likely in U.S. stocks.

 KEY POINTS TO CONSIDER

• 2022’s first corporate tax increase– Starting January 1st, 2022, companies need to amortize their Research and Development expenses, rather than expense their costs immediately. According to Strategas, this is the equivalent of a 3% corporate tax rate increase. Companies are lobbying to attach this provision to the China competition bill which is expected to pass in the first quarter of 2022.
• Worried about mid-term elections creating more problems for stocks?Turns out the S&P 500 has not declined in the year after the mid-term elections since 1946! And the average return in the year after mid-terms is 15.1%. Source: GaveKal

FREQUENTLY ASKED QUESTION

Q: The recent 7% inflation number is concerning. Should I consider adding more inflation-protected bonds?

A: Fortunately, there are many indications inflation will cool off later this year, but remain elevated in a 3-4% range for a while. While inflation-protected bonds have performed well for us in the last few years, breakeven rates have risen in line with higher inflation and future inflation expectations.  As a result, inflation will need to persist at elevated levels compared to the past decade in order for inflation-protected bonds to outperform treasuries.

One area of bonds that looks interesting – U.S. Treasury I bonds. The current interest rate is 7.12%. I bonds are inflation-protected savings bonds, issued and guaranteed by the United States Treasury. Because of the recent high inflation, I bonds purchased before the end of April 2022 will yield 7.12 percent for the next six months. If inflation stays high, so will the yield. 

An I bond has a 30-year maturity, which means it will pay interest for the next 30 years. It pays a fixed interest rate, which stays the same for 30 years. The fixed rate is currently zero percent. But I bonds also pay an inflation adjustment that is reset twice a year in May and November. The inflation rate is based on the Consumer Price Index for all Urban Consumers, or CPI-U. This includes the volatile food and energy components.

You don’t have to hold I bonds for 30 years, but you do have to hold them for one year. If you hold your I bond for one year and fewer than five years and then redeem, you’ll pay a small penalty of three months’ interest. You can redeem after five years with no penalty.

Pros:

• I bonds are paying a much better yield than almost any other bond with no risk.
• The interest is tax deferred until you want to declare it or pull monies out.
• There is no transaction cost.
• If you use the I bonds for qualified education expenses, the interest could be tax-free. There are income limits each year for this benefit – see the link at the end.
• If you have a tax refund coming, your tax preparer can file form 8888 and apply another $5,000 of your refund towards I bond purchases per taxpayer on top of the normal $10,000 limit.

Cons:

• You can only buy a small amount each year. You only can buy up to $10,000 in electronic I bonds or $20,000 per married couple. For many of our clients, this bond will not represent a material amount of their overall portfolio, but it could build over several years into a material amount of their back-up (beyond normal checking and savings) emergency savings.
• A nice interest rate on a small amount of money won’t offset much inflation on your overall budget. On a $10,000 investment, you would earn $712 in the first year, likely much less when the 6-month reset lowers the rate to 3-4%.
• Small hassle factor – these must be bought by you directly and held by you. Let us know if you buy some so we have it recorded, and post it in your record book in case heirs someday are looking for non-brokerage account assets after your death.

Note that older I bonds issued 20 years ago often have a nice base rate of 3% or more, and also get the added return every 6 months of inflation.

CLICK HERE for more information.

Introducing Our New Section –

MEET YOUR TEAM

Michele Carrera Anderson, Director of First Impressions, will add to this space once a month, after conceiving the idea to feature a member of our SFG team here.  We hope this initiative will introduce you to team members you may not know, while also adding a bit of background for those you do.

Our debut interview introduces Lindsay Brock, CFP, who works in our Greensboro office.

What is your role at SFG, and what services do you provide to our clients?

• I am a Wealth Advisor, and my role is focused on financial planning. I specialize in helping clients discover their goals and how financial planning throughout their lifetimes can help them reach those goals.

What brought you to this area of the country? What’s your favorite thing about where you live now, or where you’re from?

• So many things brought me here from the northeast: nicer weather, lower cost of living, Southern hospitality, and many of my family had already been transplanted to the Carolinas for years. What I like about Greensboro is that you can get anything you want or need; it’s a Goldilocks city (not too big, not too small), with a small-town feel.

What was your first job? Any special lessons from it?

• My first job ever (besides babysitting) was proctoring for Civil Service exams. My mother and I helped my uncle on Saturday mornings and I remember being 16 and helping administer and record the tests for people of all ages and entering all industries.

If you could snap your fingers and become an expert in something, what would it be?

• I feel like the right answer is patience, but the truer answer is time management (if I have that I can accomplish ALL my goals and develop expertise in as many things as I want).

What’s one thing you’re currently trying to make a habit, or one skill you’re trying to learn/hone?

• A colleague has invited me to try podcasting this year, which is currently WAY out of my comfort zone.

Tell us about your family.

• My husband, Tom, and I welcomed our first child, Eliza, in March of 2021. Tom is an anesthesiologist at Cone, and Eliza is well on her way to taking her first steps!

Where did you grow up?

• I grew up just north of NYC.

Who was/is your favorite relative, aside from Mom or Dad?

• My sister Samantha is my best friend. She just moved to Raleigh and we love getting our kids together (she and her husband, Bobby, have a daughter, Mia), and enjoy board game nights. My other two favorites are my Aunt Debbie in Raleigh and Aunt Annmarie in the Charlotte area, both sisters of my dad.

Dogs or cats, or both – or neither? Tell us about your pets.

• I would love to have as many of both as the house wouldl hold. Right now, my husband will only allow one: Zoe, our three and a half-year-old pit mix, who is super-cuddly and loves to destroy stuffed animals.

What was the first concert you ever attended?

• Don’t laugh – Hanson, at the Meadowlands in NJ (I was about 13). They were my sister’s favorite!

What’s your favorite local restaurant?

• White & Wood is my current fave but there are so many other new ones I can’t wait to try.

Your favorite thing to do outside of work?

• While Eliza naps or after she’s gone to bed, I love to curl up with a good book and a hot chocolate.

What’s the most fun thing you’ve ever done: at work, at home, or on vacation?

• I love traveling (Tom and I honeymooned in Greece). We also went on a couple’s vacation to Punta Cana and had so much fun on a catamaran one amazing day. I also went to Israel many years ago and would love to go back.

What’s your favorite part of your job?

• The personal bond we develop with clients – we get to share in some of their greatest joys and deepest sorrows. I don’t do what I do because I like math – I don’t like math – I’m just decent with a spreadsheet. I like making connections with people and helping them realize their dreams.

Look for this section in every other issue of the Chat.

SUMMARY

SFG’s three pillars of recovery remain in positive trend territory in 2022, although many economic crosswinds are spooking investment markets.   

Wildcard risks (low probability, high possible impact) discussed in this and previous Chats remain, suggesting some caution.  

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

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

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

Our COVID-19 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)