A Few Quick Updates

There’s truly never a dull moment, whether in life or in the financial markets. As we look ahead to summer there’s a short but weighty list of issues to follow: the debt ceiling, the banking “crisis”, the Fed, interest rates and recession risk. All this is playing out at the same time and demands our attention.

You’ve likely been wondering about these issues and many of you have been asking, so here are some thoughts pertaining to each.

The debt ceiling debate –

Treasury Secretary Janet Yellen recently said that Congress not raising our government’s borrowing limit would be a “catastrophe". I doubt she used that word lightly. As we’ve discussed previously, our debt ceiling is an arbitrary dollar amount that Congress has for years typically raised or suspended for a time. It’s been this way for over 100 years since the debt limit was created and, at least in modern times, has usually been subject to vigorous and often nerve-racking debate. This makes sense, of course, because all this deals with how much we borrow and that’s a sensitive topic for most people. (Even though the federal government isn’t a household and prudent borrowing standards we teach to our kids don’t necessarily apply, but I digress…)

So, while experts tend to agree that Congress failing to raise the debt limit, leading to missed payments and a technical default by the US Treasury, is not likely to actually happen, the same experts all expect political brinksmanship to take us down to the wire again. This is important as we’re nearing the so-called X Date when current “extraordinary measures to fund the government” dry up because the debt limit needs to be raised, not because we’re actually out of money. Our government can easily borrow more from domestic and global markets at any time.

President Biden and a variety of others are meeting on this later today. Both sides agree that the debt limit should be raised but fundamentally disagree on the means of raising it. That sounds about like a game of chicken where both sides agree they shouldn’t hit each other but neither is willing to veer away. Again, never a dull moment.

But how are the markets likely to respond? Here’s a good piece in this vein from PIMCO, the noted fund manager.

https://www.pimco.com/en-us/insights/viewpoints/debt-ceiling-debate-examining-risks-around-the-x-date/

And here’s a recent press release from the Treasury department regarding this issue. There’s no shortage of cash and access to more, we just lack Congress’s permission to keep the wheels in motion.

https://home.treasury.gov/news/press-releases/jy1460

The banking crisis –

I put the word crisis in quotes earlier because the problem’s depth is a matter of perspective. An interesting take on this comes from Gallup. The polling company recently measured how worried Americans are about the banking sector and the results were about the same as during the Great Financial Crisis, even though we’re not in the midst of that, thank heavens. And the poll was conducted last month before First Republic got swallowed up by JPMorgan!

We’re used to thinking of banks as solid and safe, even boring institutions, so it’s interesting to see how worried we tend to get about them. More educated and affluent Americans are less worried though, as are Democrats. This is flipped around from the GFC and presumably has something to do with who’s in the White House at the time. For example, in 2008, 55% of Democrats were “very or moderately worried” about banks, but as of last month Republicans held that same percentage spot.

Here’s the Gallup article.

https://news.gallup.com/poll/505439/half-worry-money-safety-banks.aspx

Whatever the reasons and political affiliations, people are concerned about how safe their cash is. This is entirely reasonable given all the news and hyperbole about the financial system lately. We’re all now probably well aware of the basics of FDIC and NCUA insurance, so I won’t bore you with that again here, but please ask if you have questions.

Instead, it’s news this week that the banking system has been functioning much better after several weeks of uncertainty. According to my research partners at Bespoke Investment Group, banks are lending to each other again and deposits are on the rise, both for the top 25 banks by assets and smaller banks as well. This is good news after the huge drop in deposits at regional banks in mid- to late-March. Loans are also on the rise, especially at the smaller banks.

That said, I’d be surprised if there wasn’t news in the coming weeks of other smaller banks getting absorbed by their larger brethren. Just be prepared for that news and try to keep your balances within federal insurance limits just in case. It’s the prudent thing to do even though risk is low.

Interest rates and recession risk –

The Fed raised rates again last week by another 0.25%, bringing its benchmark rate to 5.25%. Markets are expecting that this will be the last rate bump for awhile and even that rates could start going down later this year. Why would they go down after going up so much in recent months? Recession.

This might take longer to materialize than some analysts were expecting even weeks ago. Unemployment is incredibly low, and wages are up while slowing consistently from a high point a year ago. Housing remains strong across much of the country and the consumer is still out there buying. Inflation is still high while coming down steadily. But employers are reporting fewer job openings and they seem to be prepping for a slowdown. There’s also an assumption that recent banking issues will put a dent in lending and demand, although that hasn’t shown up clearly in the numbers yet. That’s an example of the mix of economic data coming out lately, but the overall trend seems to be softening.

So that’s where we’re at right now and mixing it all together seems to indicate a banking sector that’s dodged a bullet, and a strong economy losing momentum that, in a perfect world, would only need to dip its toe into a recession. The 800-pound gorilla in the room is the debt ceiling debate and potential default, so let’s hope that cooler heads prevail in those fancy meeting rooms in DC.

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Happiness & Taxes

Tax Day has passed for most of us, so that’s good. Or at least partly passed in the case of those delaying their filing and payment until October due to the Federally declared disaster area in Sonoma County. For me getting past mid-April is a bit of a relief each year from no longer wondering what the final bill was going to be.

But it’s also a time for wondering just where all that money goes. Different organizations track this stuff and like so much else these days the answers are available online. What I found this time is from the National Priorities Project (NPP), an organization monitoring federal spending while advocating for peace, shared prosperity, and economic security for all. Who could argue with that?

NPP looks at the federal tax haul while also showing what taxpayers from individual states pay and where that money goes. They found that Californians, on average, paid almost $17,000 in federal taxes for 2022, about $3,500 over the national average. And how that money gets allocated across the federal budget is interesting.

For example, as the chart available by clicking the following link shows, almost $4,600 of that average tax bill went to “Health” spending, funding priorities like Medicaid (the largest single expense), Medicare, and the CDC. The next largest spending category was for “Military”, including a special carve out to Lockheed Martin and a subcategory for nuclear weapons costing about $94. The rest of the chart shows spending on a host of government services you’d imagine but, alas, only about $100 went to NASA and the National Science Foundation combined. That’s more than the nuclear weapons bill, but barely enough to buy a latte.

Of course we are who we are, and all this is what it is, so to speak. We have little direct control, if any, over how our government spends our money in any given year. But if you’re curious about where your tax money is going, check out this link for some quick reading.

https://www.nationalpriorities.org/interactive-data/taxday/average/2022/ca/receipt/

Also, and perhaps only loosely related depending on your perspective, is a story from The Wall Street Journal about the happiest people in America. Tax time stresses people out and, when added to the plethora of bad news available at our fingertips 24/7, it pays to spend a few minutes thinking about our level of happiness.

According to a poll referenced in the story, the number of Americans feeling “very happy” has cratered in recent years. Those falling out of that category entered the realm of “not too happy”, while those claiming to be “pretty happy”, that middling level of happiness, has been flat over the same timeframe.

The very happy people were so few, only about 12% of the survey, that the WSJ reached out to learn more. They found some interesting common traits for what leads to happiness these days, and the story is available at the following link. One finding was that people said they got happier as they aged, which bodes well for those thinking about retirement. Physical activity and regular exercise were other common factors boosting happiness, and this regardless of age.

As before, let me know if you bump into the WSJ’s paywall and I can forward the story to you from my account.

https://www.wsj.com/articles/happiest-people-america-poll-ef7c854c?cx_testId=3&cx_testVariant=cx_176&cx_artPos=3#cxrecs_s

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To Buy or to Wait

Recent weeks have seen a whipsawing of expectations for the economy and the path of interest rates. The yield on the 10yr Treasury, a key benchmark, rose to over 4% a few times and interest rates in general have been quite volatile. But the upward path seemed destined to continue as inflation headed higher and the Fed kept raising rates to fight it. Or at least that was the dominant narrative for a while.

Lately, however, expectations have shifted given that inflation has been steadily waning and the economy, for all its pluses, seems headed toward recession. That and recent news of bank failures has pushed more investors into bonds for safety and higher yields, which has pushed the 10yr Treasury yield back below 3.5%. Other investors now think they’ve missed the boat and that maybe they should wait for yields to go back up before buying more. But will rates go back up?

The following article from JPMorgan addresses this and talks about the queasiness some investors feel about bonds given such poor performance last year. That may be true, but we still need to navigate the market we have and not wait for the one we hope for. At least according to JPMorgan, the one we have is this: We’re heading into a recession, the Fed may cut interest rates to spur growth, yields track with what the Fed does, so the bond market offers a good opportunity right now.

That logic seems pretty straightforward but, of course, it’s never that simple. There’s lots of news out there about how this and that indicator always forecasts recession, and many do. But we’ve also never gone into recession when the job market remains this strong. The official unemployment rate is 3.5%, up a tick from a historic low in February.

Maybe we enter a recession, maybe we don’t. Either way, a lot remains to be seen and the outlook and dominant narratives are sure to shift multiple times in the coming months. If nothing else, yields on short-term investments are higher than they’ve been for a long time, so I think it’s wise to put excess cash to work now instead of waiting.

From JPMorgan…

At the start of the year, the term “soft landing” was a common refrain from both policymakers and investors. However, despite the most aggressive Federal Reserve (Fed) rate hiking cycle since the 1970s, growth has remained robust and inflation has moderated. The possibility that central bankers might have managed to thread the needle by bringing down inflation without damaging growth initially pushed recession forecasts out to 2024, but the banking crisis in both the U.S. and Europe has seen a sharp tightening in financial conditions as lenders strike a cautious tone and hold back on extending credit to the real economy. This was reflected in the most recent Senior Loan Officer Survey from the Federal Reserve, which showed a sharp tightening in lending standards to U.S. firms. If credit to the economy is choked off, then the ripple effects from recent bank failures could well pull forward the timing of any recession and potentially bring the Fed’s rate hiking cycle to a premature end. 

Following the latest Fed meeting on March 22, the Chair of the U.S. Fed, Jerome Powell, acknowledged that a credit crunch would have significant macroeconomic implications that could potentially influence the trajectory of Fed policy. However, he added that “rate cuts are not in our base case.” Despite the Fed Chair’s comments, market pricing of the pathway for the Fed Funds rate has shifted markedly in the last few weeks. Investors now anticipate that a Fed pause is imminent and that they will begin cutting rates as soon as September 2023 as growth slows and inflation continues to abate.

As the Fed ponders its next step, investors should be mindful that the window of opportunity that has emerged in fixed income may slam shut quickly. The yield on the Bloomberg U.S. Aggregate Index ended March at 4.4%, close to its highest levels in nearly 15-years. However, as shown in the chart below, the yield of the Bloomberg U.S. Aggregate Index is closely tied to the Fed Funds rate; in prior recessions, as growth has stalled, the Fed has lowered rates and bond yields have quickly followed suit.

After seeing the Bloomberg U.S. Aggregate Index fall by 13% in 2022 – its worst year on record – it is understandable that some investors may feel queasy at the prospect of jumping back into fixed income markets. However, it is important to remember that the yield of a bond benchmark provides a reasonable estimate of its forward return. As such, with the current yield offered by the bond markets potentially the high-water mark for this rate hiking cycle, investors could be well-served by taking advantage of this opportunity before the window begins to close. 

Here's a link to the article if you’d like to read it in situ.

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Dining in the Dark

Good morning and I hope your day is going well so far. I’m at a conference as I write so this week’s post will be brief. This is the first in-person conference I’ve been to in a few years for obvious reasons and it’s good to be back at it again.

This time it’s the Financial Planning Association Retreat and I hope to bring you some notes from my time here in the weeks ahead.

One tidbit was the opening session last night, Dining in the Dark. Attendees were led to dinner in groups of ten standing in a tight line, with one hand on the shoulder in front of you, because we were blindfolded! I had no idea we’d be doing something like this. I thought the name implied dining by candlelight, or some other “dark” culinary experience, whatever that might be. Instead, it was three courses over what had to have been at least 45 minutes in utter darkness. Apparently about 20% of the room had to remove their blindfolds for various reasons, while your humble financial planner was able to stick it out. I think I cleaned my plates, but I know I didn’t spill anything into my lap, so that’s good.

All this was a prelude to the opening keynote talk about perseverance, optimism, gratitude, and kindness, presented by a blind person. I’ve been to a bunch of these talks over the years and the speaker’s bios are meant to impress, but this speaker was one of the most impressive people I’ve heard by far. Corporate executives ascending high peaks a world away takes planning and fortitude and is certainly an impressive feat. But losing your site as a young adult and then intentionally planning and executing a fruitful life in the decades since has the weekend warrior climbers beat, hands down. Frankly, most of us have no idea what true adversity is and we’re lucky for it. It’s good to be reminded of that from time to time, and to add some more blocks to our gratitude foundation. It’s also good to be reminded of all that is possible if/when we get out of our own way.

Otherwise, I wanted to share a few notes on recent events in the banking sector. As you’re likely aware, this past weekend saw another shotgun banking marriage, except this time it was brokered by the FDIC between JPMorgan and First Republic Bank. JPMorgan, the largest bank in the country (by deposits) was allowed to get bigger by acquiring the deposits and most of the assets of First Republic, the SF-based institution that catered primarily to well off and entrepreneurial clients. I say allowed because JPMorgan’s too-big-too-fail size had technically precluded it from buying another bank, but the bank received special permission to do this deal. Frankly, the mega bank seems to be making out like a bandit here, but that’s just my opinion.

So what does this mean for First Republic depositors? This is a fast-moving situation, but JPMorgan says that all First Republic branches are open for business, the website still works, and current terms of deposits and loans should remain that way for at least a while. JPMorgan executives were understandably nonspecific about many details when speaking to the press yesterday, but this seems like pretty decent news overall for First Republic customers. (I think common stockholders get nothing, by the way.) The alternative was a full takeover and liquidation by the FDIC, which creates a lot of headaches for regular people trying to access their cash.

I mention all this because of what a non-event this seemed to be for the markets and the banking sector as a whole. (That was yesterday - markets are down a bit as I write this morning.) There are other banks with problems like First Republic but, at least at this point, none of them seem poised to tank the financial system or otherwise cause a ton of market volatility as they work through it. This is a good sign for the rest of us in that the banking sector has been able to absorb these issues without creating contagion like during the Great Financial Crisis. Let’s all be grateful for that!

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The Everlasting Promo Rate

Some time ago I wrote about subscriptions and how easy it’s become to let them accumulate. Our subscriptions can be a chunk of our monthly expenses, so it makes good sense to track them down, decide what to keep, and jettison those that are unused or simply no longer necessary.

This is easier said than done, however. Part of the reason for this is that many companies offering subscription-based services seem to have a knack for obfuscation. Maybe they make you call and wait out a sales pitch before canceling. Or maybe the company tucks the cancelation link somewhere so cleverly that people tend to just give up and let it ride for another year (or five!).

The Federal Trade Commission has recently proposed a new rule that would require companies to make it as easy to cancel services as it was to sign up for them or face a fine of up to $50,000. Industry groups don’t seem to be fighting this, so maybe we humble consumers might eventually get some relief. I hope so!

I mention this because after months of higher-than-expected inflation and months yet to go before we get back to something resembling normal, consumers are paring their spending back so far this year. We’re seeing this in the official retail sales numbers from the government that came out last Friday and in some corporate earnings reports, but also in surveys asking about things like subscriptions.

According to the following article from the WSJ, consumers report that their “biggest financial mistake last year” was paying for unnecessary subscriptions and that these totaled at least 50% more than assumed. While the actual dollar values could be relatively small for some households and many might suggest not sweating the small stuff, for others, such as those living on a fixed income, canceling some subscriptions can make a meaningful difference to cash flow.

The bottom line with subscriptions is we should try to evaluate the ones we have, especially those on autorenewal, and decide about keeping them going. This sort of diligence can help uncover money that’s being wasted because we’re not even using the service we’ve been paying for. It can also help us reduce the cost of services we enjoy.

For me an example of the latter is my Sirius subscription. For years I’ve had one of their basic services in my truck and have typically paid about $7 per month. That’s a promotional rate but I’ve been keeping it going. I calendar the annual renewal because otherwise the going rate is about $23 per month. So each year I log into my account, chat with a rep and ask for the discount, all of which takes maybe 10-15 minutes. The whole process is pretty annoying, but I do it after being burned by a roughly $30 per month OnStar service that I let hit my credit card for almost a year before shutting it down and couldn’t get all the money back. Yes, I’m still a trifle bitter about that… and don’t even ask about my McAfee experience.

Apparently lots of people let their promo rate lapse and move up to full price and let that ride for months or even years. It’s part of the business model for many subscription-based companies. The higher standard rates also subsidize the promo rate for new subscribers and those, like me, who keep asking for it. I tell myself that I’ll outright cancel Sirius as soon as they refuse to continue the promo rate because their service is obviously more fairly priced at $7 than $23, but they haven’t yet so I’m a happy subscriber.

Take my Sirius example and stretch that out over your subscriptions. Do services you enjoy offer a lower rate but just haven’t told you? Have you asked for a discount? Again, this might seem like small potatoes, but I think it’s a good exercise to go through from time to time. It will help lower your recurring expenses and provide a sense of ownership over your finances as inflation seems to be eroding it away.

Here’s the WSJ article I mentioned. Let me know if you get blocked by their paywall and I can send you the story from my account.

https://www.wsj.com/articles/people-are-sick-and-tired-of-all-their-subscriptions-cbee7e03

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Quarterly Update

The first quarter (Q1) of 2023 ended well for stocks and bonds, making for the second positive quarter in a row. It was a nerve-wracking time for investors, however, as bad news seemed to continually outweigh the good.

Here’s a roundup of how major markets performed during the quarter:

  • US Large Cap Stocks: up 7.5%
  • US Small Cap Stocks: up 2.7%
  • US Core Bonds: up 3.2%
  • Developed Foreign Markets: up 9%
  • Emerging Markets: up 4.1%

It’s been a rough ride for investors in recent quarters, and especially those with a moderate risk tolerance who hold stocks in their portfolio but also a sizeable portion in bonds. Both asset classes were down last year, so it’s great to see positive returns to start 2023. Those returns weren’t easy to come by. Whether it was continued news about inflation and how much and for how long the Fed would keep raising interest rates, mixed with bank failures during March, the news cycle played havoc with investor sentiment throughout the quarter.

Across markets, tech stocks that took a beating last year were up the most during Q1. Chipmaker NVIDIA, Meta (the parent of Facebook), and Tesla were each up over 60% by quarter’s end but the latter two stocks and the sector as a whole are still down over the past year. There are a variety of explanations for this positive turn but for sectors like Tech and Communication Services this was primarily a snapback as sentiment shifted around the likelihood for a softer recession than originally feared.

The worst performing sector was Financials, down almost 6% in Q1, for reasons obvious to anyone paying even remote attention. While inflation was still a foundational theme for the quarter, early March greeted us with surprise news that Silicon Valley Bank, a large but “local” CA institution, had been seized by regulators following a bank run lasting just a few days. Then another, Signature Bank of NY, was shuttered and quickly everyone everywhere was waiting for the next shoe to drop while checking up on their federal deposit insurance. A short time later we had news that another publicly traded bank, First Republic out of San Francisco, was on the ropes. The Fed and others quickly came to the banking system’s rescue, buoyed First Republic, and generally settled everyone down. The result, at least in part, was the positive broad market performance posted above.

Another result of March’s mini banking crisis was a major shift in the outlook for inflation, Fed interest rate moves, and recession. Inflation rose quickly last year before peaking midsummer. Since then inflation has been trailing off every single month. Unfortunately inflation was still about 6% as of February, 4% higher than the Fed’s target. During Q1 this meant that the Fed raised short-term interest rates by 0.50% spread over two meetings, a slower pace than in prior months. But given reverberations from the bank failures already mentioned, the Fed is expected to slow its pace further, or even stop raising rates, as it waits to see how these events might help reduce inflation.

Potentially impacting the Fed’s assumed “dovish” turn is a realization that they’ve already done enough in the last year to slow the economy, perhaps too much. A variety of indicators suggest that we may already be in recession or might be in one soon (as a reminder, recessions are only called well after they’ve started). GDP data has been weakening and leading economic indicators are pointing to recession. The yield curve that we’ve discussed elsewhere is also deeply inverted and that’s always indicated a coming recession when the inversion is this large. And specific sectors of the economy, such as housing, are already there on a national basis.

On the bond side of your portfolio, expectations for a gentler Fed helped bonds recover a bit during Q1, with the primary bond index returning over 3% for the quarter. Bond investors are now assuming the Fed starts lowering rates during the second half of this year, based on the recession risks already mentioned. Only time will tell who’s right, of course, but it’s always interesting to watch bond investors trying to anticipate Fed policy.

While all this might sound downright gloomy for investors, April has typically been one of the strongest months of the year for stocks. And, according to Bespoke Investment Group, year three of a presidential election cycle is often quite strong as well. Beyond that, and from a contrarian perspective, market sentiment is abysmal and that typically bottoms before stocks start a longer positive run. We could be looking at a seemingly ironic situation where our investments start doing better as the broader economy starts doing worse, part of the normal long-term cycle.

So what should we be doing in this sort of environment? The news cycle will continue to be crazy, but we should keep charging ahead with our investments while managing risk in a prudent way. And with the rest of our personal finances we should take stock as we plan for recession. Evaluate your cash needs and review your personal liquidity structure. Try to pay down any higher-rate or variable debt and avoid taking on new debts if possible. The recession may be mild by historical standards but, whatever the length and severity, it’s best to plan ahead anyway. As always, we’re here to help in this process.

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