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.”
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.
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.
Choices are about to be made. Central banks and legislatures seem poised to decide what they want to do. For central banks, “plentiful liquidity helped governments, businesses and households survive lockdowns. Cash flows collapsed but bankruptcies barely increased.
This issue includes a seasonal cornucopia of tax-related news: a new tax guide, good news from Social Security, and thoughts on tax revenues and the “tax gap.”
As we wait for the financial world to react to events while unsure of what theme or themes will predominate economic thought in the future, there are some strategies and tactics to keep in mind during tricky times. A popular endowment model strategy is rebalancing a portfolio. As different sections of a por tfolio gain value quickly, or slowly, or even regress, the original, and hopefully optimal, asset allocation percentages change to something different. At various times, perhaps annually, the increased percentages are sold down to their original allocation and the funds raised are reinvested in the decreased percentage assets, thereby rebalancing. As a tactic to make some investors comfortable with the risk profile of their portfolios, this works. However, one author points out that he has “yet to see a study that shows it improves your returns,” and in fact it sometimes can mean “missing out on big returns.”
With the pandemic subsiding and economic growth reaccelerating, a Bloomberg survey of economists expects US real GDP to grow a robust 6.6% this year and 4.1% next. The economy (as measured by real GDP) is expected to have surpassed its pre-pandemic peak in the second quarter of 2021. The S&P 500 Index returned a strong 14.4% through the first half of the year to close at a record high. Pent-up demand and federal stimulus funds have meant that demand for goods and services has recovered much faster than supply. Businesses can’t hire workers fast enough and they’re struggling with supply chain bottlenecks. Strong economic conditions drove the Consumer Price Index (CPI) up 5.4% year-over-year in June, following up 5.0% y/y in May. While many economists had been expecting some inflation, these inflation statistics were higher than most of them, including many Fed officials, anticipated. The CPI excluding food and energy was up 4.5% y/y in June, reaching its highest level since 1991.
We’ve heard from our portfolio managers that some clients are asking about tax planning in an unsettled regulatory environment. News reports of changes to US tax laws cover a wide range of proposals — too many and at too early a stage to meaningfully discuss planning and tactics.
Measuring the effects of increased oversight and regulation brings us to the fiduciary rule: always putting the client’s interest ahead of our own. Since this is part of the Investment Company Act of 1940, we at Woodstock have been complying with this rule for all of our registered investment company life. We plan to follow it in the future.