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  • Writer's pictureMichael Handy

Fourth Quarter 2022 Newsletter

Fourth Quarter 2022 – The fourth quarter provided good returns in an otherwise terrible year. No area of the market was spared last year. Fixed income (PIGIX) is usually an offset to equity declines. This year the fixed income decline was similar to equities since interest rate increased at a staggering pace in the Fed’s effort to combat inflation. The annual three-year returns for equities, 7.59% for large US Companies, 7.88% for small US companies, are favorable long-term returns. Real estate at 0.36% and five-year bonds at -3.61% suffered the most from rising interest rates.

Statistics are from Morningstar Advisor Workstation which are considered reliable.

The Market Correction – The market correction for 2022 was a combination of inflation, beginning high market prices, Covid, interest rate hikes and the war in Ukraine. Covid is still a major factor today. At the onset of Covid, businesses reduced expansion plans. With the Covid recovery, demand increased, leading to bottlenecks in the supply chain with demand exceeding supply. Inflation followed with slow percentage decreases in the annual rate toward the end of 2022.

Labor and Employment – The employment market after the Covid pandemic phase revealed a labor participation problem. This is important because lower employment participation affects inflation rates. Fewer labor participants increase the labor demand for the remaining participants resulting in labor inflation. The working population in the US is five million people short at normal labor participation rates. More baby boomers retired or didn’t return to employment after Covid. Long-term Covid also contributed to declining labor participation. At year end according to Barron’s, two jobs were available for each job applicant. Unemployment stood at 3.5%.

What’s ahead for the market – The consensus among analysts according to Barron’s and other sources, is the market will be soft in the first half of the year with the Fed fighting inflation, and a mild recession may result. An improvement will happen in the second half of the year. Supply is beginning to catch up with demand. Companies are looking to expand believing inflation will be down at year end and a mild recession has been priced into the market.

Your Portfolios – Investments will continue to be broadly based across many different asset classes. You have the top mutual funds and ETFs from Dimensional, Vanguard and PIMCO. Individual equities are in excellent companies. With interest rates increasing, investments in fixed income have improved. With the market in an intermediate holding pattern, an investor is being paid to patiently wait.

Capital Loss Harvesting – Taxable portfolios have been analyzed with positions sold to generate capital losses. These losses offset capital gains from funds and are deductible up to $3,000 per year. They can also generate losses to offset gains from real estate sales. Excess losses above $3,000 are carried forward. Some of the losses are generated by trades within an individual investment. For example, if ten trades were made in one stock over time, and three had losses, those three would be chosen and sold. The sold money from funds could be reinvested in thirty-one days or invested in a similar stock. A good example would be sell Pepsi (PEP) and buy Coke (KO). Or sell a Bank of America preferred stock (BAC-Q) and buy a Wells Fargo preferred stock (WFC-A). The investment is staying relatively the same and a tax advantaged loss is generated.

Nuclear fusion – A major development in 2022 was nuclear fusion. Nuclear fusion happens when two or more atoms are fused into a larger one, in a process that generates a massive amount of heat energy. Our current nuclear process of fission is the opposite; it splits a larger atom into two or more smaller ones. Nuclear fission today produces energy to power reactors but also produces nuclear waste. While fusion and fission are both a zero-emission energy source, fusion does not carry the same safety risks, and the materials used to power it have a much shorter half-life than fission.

This amazing development has received little press reminding us of the internet in 1983. Practical uses for fusion are seen as ten to twenty years in the future. But like the internet, developments could come at a rapid pace. Besides nuclear, our other sources of energy are centuries old: coal, oil, gas, wind, hydro and batteries. Fusion development will dramatically change the way we use energy in decades ahead and have everything to do with geo-politics. OPEC, Russia, and dictator nations with oil and gas would become less relevant as producers of energy.

Investing in this change will be the challenge. The utility companies would be large investors as well as industrial companies. Moving vehicles and equipment would use this energy source. The Amazon, Apple, or Google super companies of fusion may materialize. It would be good to have them US based!

If endorsing this amazing development results in votes and campaign contributions, our esteemed politicians will jump on board.

US Elections – Turnout was strong for the midterm elections. Voters rejected many candidates who followed the false narrative of a stolen election in 2020. The result was a slim Republican majority in the House and Democrats maintained a majority in the Senate. An anticipated red wave in the House never materialized.

The surveys showed the top issues for American voters were inflation, women’s reproductive rights, health care, voting rights, immigration and climate change. Some Republicans in the House have a priority of investigating the president, the president’s son, members of the cabinet, the January 6th committee and Dr. Fauci. Investigations were 17th on a list of voter concerns.

The current combination of a Democrat president and Senate coupled with a Republican House is favorable for the market. Fewer regulation changes, minor tax law changes, and no substantial increase in IRS agents. The first major decision for the House is the upcoming fiscal policy budget in the Spring and Summer.

Social Security – The cost of living (COLA) increase was 5.9% for 2022 and 8.7% for 2023 for a total of 14.9% and an average of 7.3%. For the prior thirteen years from 2008 to 2020, the COLA increase was 18.7%, or 1.44% per year. These increases have added substantial sums to the Federal budget (see below).

Social security is a pension plan with contributions, investments, retirement and disability payments. The variables for pension calculations are known or can be estimated like longevity and rate of return on investments. The knowns are current participants receiving benefits and employees making contributions.

The House spends taxpayer money. They need to develop a fifty-year plan for social security instead of minor fixes. It should include having a portion of the pension in equities like most pension plans. This seems unlikely in the House currently situated focused on investigations and redressing grievances.

The Federal Budget – The federal budget has these four components:

Politicians like to talk about the lowering the budget. What they don’t like to discuss are the details involved in lowering the budget because they are painful and taxpayers vote. It is easier to make modest changes and kick the problem down the road. When you want budget changes you look at the large items. Besides interest, which is required absent default on government bonds, what is the plan for changing the top three budget items?

Highlights from Jessica’s Desk

IRA Beneficiary Designations – Most of you have designated beneficiaries for your investment accounts, but it is always important to keep that information up to date. Now is a great time to check the status of your beneficiaries, and make sure all your accounts have at least one. A common issue here involves name changes, so if one of your beneficiaries has changed their name, contact Jessica to get it updated with TDA!

Taxes – If you utilize our tax services through Handy & Reagan, LLC, please give us a call to schedule your tax appointment. Sooner is always better! We will be sending out your tax organizers for 2022 in the next few weeks.

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