Where are Americans’ retirement assets? As of June 30, 2022, IRAs were the most popular vehicle, according to data from the Investment Company Institute, with $11.7 trillion. Defined contribution plans—such as 401(k), 403(b) and other plans—hold $9.3 trillion. The time-honored defined benefit plans hold a total of $10.5 trillion, but these are skewed to government plans ($7.3 trillion); private sector plans hold just $3.2 trillion because of the government’s excessive regulation of private defined benefit plans. The surprise is that annuity reserves account for only $2.2 trillion.[1] The grand total is $33.7 trillion worth of assets invested. The pension benefit obligations of defined benefit plans, particularly for government plans, may be more than the assets, meaning they are underfunded.

The major news stories of the day will have an impressive impact on the financial markets: Russia’s war in Ukraine, escalating China versus US competition, and the worldwide effort to control inflation. However, there are minor story lines which may show an investor a path through the turmoil: the put-spread collar, liability-driven investing, and which financial market “rules.”

We are all data dependent and we will all react together. The entire world is data dependent. In this observer’s opinion, the phrase “data dependent” may be the second most commonly used term behind “climate change” today. Federal Reserve policy makers are data dependent. Corporate managements are data dependent, and because security analysts rely on company guidance for the bulk of their revenue and earnings growth forecasts, stock opinions and ratings are data dependent. No wonder there is so much attention and focus on this Fed meeting or that real GDP and unemployment report or what bond yields are doing and whether the curve is inverted or not. It is a large laboratory experiment in large group action and reaction.

The stock market has seen its share of peaks and valleys over the years. The peaks can be a euphoric time with the rapid growth of account market values and the accompanying wealth effect. Conversely, the valleys can have just the opposite effect—both fiscally and mentally. To see your statement market value moving in the wrong direction can bring about a feeling of helplessness. Many people need a certain performance return on their savings to meet daily living expenses or to one day comfortably retire, and the equity market has historically proven to be an effective place to meet the necessary return. We need the good, but would prefer to avoid the bad (risk!). So, how should an investor react to the recent market pullback?

According to figures for tax receipts for the nine months ended June 30, 2022, the Internal Revenue Service (IRS) was projected to take in $5 trillion for fiscal year 2022, ending September 30th.[1] Last year’s figure was $4 trillion. For the period through June 30, 2022, individual income tax receipts made up 56% of the amount taken in and social security and retirement receipts made up 29 percent. The other 15% is made up of corporate income taxes, excise taxes, and custom duties, with estate and gift taxes making up just .6% of the total. The year-over-year increase in receipts would lead one to believe that the federal government has a spending problem, not a revenue problem. National defense is just 13% of spending. Social Security, income security, health and Medicare make up 65% of expenditures.

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.

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.

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).

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!”

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.