Second Quarter 2022 – The investment returns are a confluence of inflation, rising interest rates, and Russia. When interest rates rise, all investment areas decline. Inflation and concern about a recession cause projected earnings to decline. For the three-year period, you received acceptable returns. The US led the way with 10.55% for large US companies, 7.77% for small US companies, and 5.40% for real estate. A combined 60/40 portfolio yielded 4.95%.
Statistics are from Morningstar Advisor Workstation which are considered reliable.
Where we are – Most of you don’t follow the market daily. We are in the market every day, purchasing, selling, rebalancing. We use our software and read subscription research. The markets are down for known reasons. Corrections of 10% or more happen every two years on average. Securities buy or sell on expectations, with history as a guide.
What we do – You have excellent investments from Dimensional, PIMCO and Vanguard. Stocks and bonds you own are from large, well-known companies. You don’t realize a loss until you sell. So, we stay put with our excellent investments. Rebalancing takes place when needed and cash made available when needed for the short term.
What’s ahead for the market – The keys are interest rates and inflation. The Fed keeps the target inflation rate at 2%. The Fed will continue to raise rates until inflation recedes. The goal is to reduce inflation without triggering a recession. Barron’s writers and others are projecting a stronger second half of the year. Inflation has remained persistent, not temporary.
Reversion to the mean – This is a statistical term. It asserts prices over time will return to their average. The stock market had high values at 2021-year end. Stocks traded at 20x earnings. The market has since reverted to the mean between 15x and 17x or a 15%-25% correction. Expensive growth stocks declined the most.
Recessions – The economist definition of a recession is two or more quarters of negative economic growth. A recession can be mild or severe. The threat of a recession lowers stock values. The question becomes, is the US heading for a recession and will it be severe? Some indicators are encouraging, others negative.
Jobs – One component negating a severe recession is jobs. New jobs are growing. According to Barron’s and other sources, 1.9 jobs are available for each applicant. Businesses are growing and hiring. This can change if business slows and profits decline. If employed, you can weather higher inflation and daily expenses in the short run.
Autos – Loans are experiencing higher delinquencies. Covid aid dollars bought autos. Lenders considered government payments for credit purposes. Auto values follow depreciation models. As autos age, value decreases. Used vehicle prices inflated due to shortages. They will revert to mean with many car owners upside down on loan to value. These losses could affect returns in some bond-type investments.
Real Estate – Interest rates for homes have doubled over the last year. First time home buyers tend to buy based upon monthly payment. A $300k, 30-yr home loan is $1,265 per month at 3% and $1,799 per month at 6%, a $534 per month difference. Home prices are currently built on a 3% interest rate model. Home values increased with low 3% rates. A 6% interest model will disqualify more buyers.
Yield to maturity – Different markets present different opportunities. Bonds have a par value of $1,000. Preferred stocks have a par value of $25. Your direct investment in these securities is for maturity in three to seven years. This means the bonds pay you back the $1,000 and the preferred stocks pay you back $25. You get the interest and dividends income while owning the securities.
Bonds and Preferred Stocks – In this market, we found bonds and preferred stocks selling for below par value, less than $1,000 and less than $25. This means you receive a gain on maturity along with the income you have received. The effect is to provide yields of 10% or more for a bond or preferred stock investment. In both cases your investments are in well-known companies. Banks and financial institutions dominate preferred stocks. Wells Fargo, Morgan Stanley, Bank of America, and JP Morgan have current yields of 6%. Their yields to call exceed 10% (interest while owned, plus a gain on redemption). These banks are not required to call or redeem their preferred shares, but the norm is redeeming. If they delay redemption, you continue to get interest returns of 6%. AT&T and Allstate have 5%-6% current yields and 10% yields to maturity.
Upcoming elections – Amid dominating current issues, the mid-term elections loom. The consensus is the Republicans will reclaim the house, and the Senate remains a toss-up. One ABC commentator called a Republican change in the house a revenge tour. You may see a slate of bills devoid of legislation, rather motions for righting perceived injustices by the Democrats. It matters to the market because little legislation will be forthcoming. This means less regulation changes and more predictability. Republican legislation in the toxic Washington environment faces challenges, and likely vetoes by a Democrat President. This could mean that attention becomes dominated by the 2024 elections. A Biden tax bill appears doomed.
Highlights from Jessica’s Desk
RMDs – We will be distributing the 2022 annual RMDs in the next month or so. If you have any changes to how you would like your funds distributed, please contact me at 503-635-6100 or email@example.com to let me know, and I will make sure we update your file.
RMD via Qualified Charitable Contribution – If you are required to take distributions from your IRA or Beneficiary IRA account, you can avoid paying taxes on your distribution by donating the money directly to charity. This tax break does mean that the donor cannot also claim the donation as a deduction on Schedule A of their tax return. Other donations to charity that don't use IRA funds, however, can still be claimed as an itemized deduction.
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