Quarterly Market Perspectives

Wall Street Catches Up

News, Quarterly Market Perspectives
Wall Street Catches Up. Illustration of hands reaching for capital

Technology is allowing an investment strategy that was previously available mostly to high-net-worth clients to now be mass marketed: A customized portfolio can be offered to every client. Compared to a passive portfolio invested in pooled investments products, “direct indexing” seeks to mimic an index by owning all, or a representative portion, of the stocks in the index, individually. The next step to “custom indexing” allows the broker and the client to pick and choose those stocks from the index to invest in and hold.[1] The new products introduce the concept of tax-loss selling and its benefits to a wider audience. Not too long ago, Wall Street had suggested tax law changes to Congress which would have curtailed tax loss selling generally. Hopefully, the new push to mass market custom indexing will prevent that from recurring.

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A Difficult Period for Stocks

News, Quarterly Market Perspectives
A Difficult Period for Stocks. Illustration of stock performance

The first half of 2022 was the worst first half for stocks since 1970 and the worst six months for bonds since 1980.[1] The S&P 500 Index returned -20.0% while the iShares US Core Aggregate Bond ETF returned ‑10.2 percent. The 10-year US Treasury finished June yielding 3.02%, double the 1.51% at which it began the year. Reversing much of the stock market’s strong performance in 2021 (+28.7%), stock price levels returned roughly back to where they were in March 2021. Stocks are trading at cheaper valuations now. Markets have been rocked not only by runaway inflation, but also by the Fed’s prescription to rein it in.

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Tax Update: Tax Law Changes

News, Quarterly Market Perspectives
Tax Update: Tax Law Changes -- illustration of legal system

The purpose of our government-directed tax system and the intended and unintended consequences of tax law changes, along with the mechanics of the tax system itself and a particular tax-saving strategy are the focus of this issue’s Tax Update.

While large corporate or individual tax increases seem to be off the table at this time, it is worth reviewing the idea that tax rate decreases can actually increase government revenue and increase benefits to individuals even if the changes are made to other than their individual rates. A review of 2017’s tax reform effort, the 2017 Tax Cuts and Jobs Act which reduced the federal corporate tax rate to 21% from 35% and liberalized expensing of new equipment investing, shows that it actually delivered both average household real income gains and higher corporate tax revenue, both absolute and as a higher percentage of gross domestic product over the two-year period after passage.[1] The focus on domestic corporate business expansion enhanced worker bargaining power to provide a bigger increase in household real income in 2018 and 2019 than in the previous eight years of a weak recovery (from 2010 to 2017).

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Why Investing Directly in Stocks Serves Investors Well

News, Quarterly Market Perspectives
Why Investing Directly in Stocks Serves Investors Well. Illustration of stock tracker

What do you buy when you make high-quality US companies the basic building block of your portfolio? The short definition of a high-quality US company is one “that can grow and thrive under almost all envisioned economic scenarios” with the investment expectation that their “capital will compound at a healthy ‘real’ rate” meeting “any reasonable investment objective.”[1]

Leaving aside for the moment the discussion of “active” versus “passive” (see QMP Winter 2022), for the last twenty years this asset class has received disparaging comments from the endowment model community and from Wall Street investment managers as too predictable and unexciting. They say that with the right professional guidance, an investor could do better. As Charlie Weis, the former professional football coach and now commentator, says about NFL teams’ bad decisions: “How’s that working out!”

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As the Fed Fights Inflation, Can Recession Be Far Behind?

News, Quarterly Market Perspectives
As the Fed Fights Inflation, Can Recession Be Far Behind? Inflation Illustration

The S&P 500 Index dipped briefly into correction territory in mid-March (defined as at least a 10% fall from a recent stock market peak, which it hit January 3rd) before rebounding to close out the first quarter down only -4.95% as of March 31st. The tech-heavy Nasdaq Composite Index was off -9.1% on a price-only return basis for the quarter, but technically has been in correction territory since mid-January, down -11.4% from the highs it hit November 19th. Likewise, bonds had a tough quarter, finishing in the red with long-term Treasurys down -10.2%. Energy and utilities were the only equity sectors with positive price returns, +37.7% and +3.9%, respectively. All of these markets were digesting news of the Russian invasion of Ukraine, high energy prices, surging inflation, and a Federal Reserve turned hawkish with forecast aggressive federal funds rate hikes and open market bond sales to shrink its balance sheet. The question everyone is asking: Can the Fed orchestrate a soft landing with so many variables to combat? Not likely.

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Tax Update: Extensions, Capital Gains, & Social Security

News, Quarterly Market Perspectives
Tax Update: Extensions, Capital Gains, & Social Security - alarm clock illustration

The first phase of the current tax season has ended. The flurry of activity to make sure that tax returns for 2021 are filed or, at least that the tax due is paid with the request for an extension, is done.

The Internal Revenue Service estimates that 15 million taxpayers requested an extension of time to file their 2021 tax return. An extension of time to file is not an extension of time to pay. Taxpayers must estimate their tax liability and pay any amount due by the April due date to avoid penalties and interest.

Filing a tax extension to file a tax return does not increase your risk of being audited, according to both the IRS and various tax professionals. Historically, it has been proven that individuals who earn $200,000 or more a year have a 3% greater chance of being audited. According to IRS data, the IRS audited 1% of people earning less than $200,000 and 4% of those earning more than $200,000.

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Trends to Watch in the Year Ahead

News, Quarterly Market Perspectives
Trends to watch image of computer screen

In thinking about what may happen financially and economically over the next several years, we realize that much depends on how countries and their citizens react to medical issues. For perspective, Marcel Proust wrote in 1913: “For, medicine being a compendium of the successive and contradictory mistakes of doctors, even when we call in the best of them the chances are that we may be staking our hopes on some medical theory that will be proved false in a few years. So that to believe in medicine would be utter madness, were it not still a greater madness not to believe in it, for from this accumulation of errors a few valid theories have emerged in the long run.”

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Inflation Presents a New Challenge

News, Quarterly Market Perspectives
Inflation present a new challenge image of investor

The S&P 500 Index returned 28.7% in 2021, following a 18.4% return in 2020, and a 31.5% return in 2019. Observers would be forgiven for not associating any of these returns with a two-year global pandemic. The index has in fact compounded at a 16.6% rate over the last 10 years. Equity investors have rarely had such excellent long-term returns. Last year, economic fundamentals were excellent too, with US GDP expanding 5.7% in real terms, surpassing its pre-pandemic size on a seasonally adjusted basis in the second quarter of 2021. S&P 500 Index earnings fell 13.9% in 2020 before rebounding an estimated 46% last year. The economic expansion and earnings rebound have been greatly helped by monetary and fiscal stimulus.

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Tax Update – Revenue Debates and the IRS

News, Quarterly Market Perspectives
Tax Update - Revenue Debates - image of taxpayer floating

Sometimes changes to the US tax code seem like they are “floated” just to stir up money-making opportunities. Interest groups react to proposed changes by contacting, and throwing money at, lobbyists who counsel Congress against or for whatever was floated. There seems to be no recognition that managing the US tax code should be treated as a steering mechanism on a $20 trillion “truck.” Care should be taken when operating it, as if even a slight wrong move can send it careening.

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