"There are decades when nothing happened then there are weeks when decades happen." -Vladimir Ilyich Lenin
We've seen events occur in the first half of this year that we haven't seen in quite some time. We started out 2022 facing the highest rate of inflation in 40 years. The combination of low interest rates for an extended period of time, unprecedented stimulus from COVID relief packages, a labor shortage, supply-chain bottlenecks, then a global recovery from the pandemic causing an increased demand on energy all forced inflation to come roaring back in late 2021. The hope was that as the Federal Reserve increased interest rates and COVID cases and restrictions faded, 2022 would be a year of transition toward more normal levels of employment, corporate earnings, supply of goods and services, and economic growth.
Then came the unexpected invasion of Russia into Ukraine, which was a watershed moment. This event, combined with the new lockdowns in China due to COVID, dramatically changed the landscape for inflation and created a new set of challenges towards economic, financial, and political stability. At present, there are no signs that inflation will subside to more normal, healthy levels anytime in the near future. This caused the Federal Reserve to hike its benchmark interest rate by 0.75% on June 15, 2022, the largest single rate hike since 1994. Further rate hikes are expected by the Fed to slow the economy and curb inflation. But will it be enough? The challenge is to avoid slowing the economy so much that it puts us into a recession. Jerome Powell, Federal Reserve Chairman, recently commented, "The events of the last few months around the world have made it more difficult for us to achieve what we want."
What would it mean if we went into a recession? A recession is generally defined as two consecutive quarters of negative GDP (economic growth). During a recession, manufacturing and services decline and businesses sell less products and services. This often results in employee layoffs, among other things. However, a slowing economy can bring prices of goods and services back down and reduce inflation to a more healthy level. Since the Great Depression, we have experienced 12 recessions. Historically, recessions have lasted less than a year. The "Great Recession", however, caused by the subprime mortgage crisis, lasted from December 2007 to June 2009 and was the longest one since the Great Depression.
The risk of a recession occurring in 2023 or 2024 is increasing, which is why the Federal Reserve has been aggressively hiking rates. Stated recently by Rob Lovelace, Vice Chair and President of Capital Group, "I see a moderate recession as necessary to clean out the excesses of the past decade. You can't have such a sustained period of growth without an occasional downturn to balance things out. It's normal. It's expected. It's healthy." Because a recession can affect your personal finances, preparing for one means shoring up your personal finances by reducing debt, building cash reserves, securing or improving job security, and holding off on major purchases since prices of goods and services often fall during a recession making them more affordable.
With the threat of continued inflation and a looming recession, stock markets have declined dramatically thus far this year. As of June 29, 2022, the S&P 500 is down roughly 20% year to date and the Nasdaq is down roughly 26%, both indices now in bear market territory. The term bear market is used when a stock market falls more than 20% in value from its recent high. Whereas a recession describes the health of the economy, a bear or bull market describes the health of the stock markets. Since World War II, there have been 17 bear markets. Other than brief declines in 2020, 2018 and 2011, this is the first full bear market we've experienced since 2007-2009. On average, they have lasted about a year, producing peak-to-trough declines of nearly 30%. The deepest bear market occurred in 2007, as a result of the ‘07'-09 financial crisis, with the S&P declining 56.8% from its high and lasting 17 months. The longest bear market was 2000-2002 when the "dotcom" bubble burst, lasting 30.5 months. Though a bear market and a recession often overlap, one doesn't always cause the other. Bear markets that have occurred outside of a recession, however, have been shorter in duration.
Despite threats to the economy and markets, investment opportunities still exist for investors, though there may be a shift in market leadership. Investors have historically been rewarded for taking a long-term view to investing, especially during market declines. The linked PDF titled "Keys to Prevailing Through Stock Market Declines" by Capital Group/American Funds is a valuable investor guide that makes that point. But why take the risk at all by investing in stocks? For the long-term investor, risk is the temporary price we pay for the opportunity to earn returns that can beat inflation.
Though we continue to maintain a long-term investment approach, we have been working to position our clients' accounts should we have an extended bear market, sustained levels of high inflation, or a recession. In doing so, we're looking to hold funds that own attractively valued companies that have demonstrated the ability to thrive regardless of the economic environment. We're also reducing more aggressive assets, increasing our weighting of value over growth stocks, and slightly reducing traditional bond holdings for other sectors. Though holding bonds this year has not provided the negative correlation to stocks as they often do, they should once again resume their role of hedging against equity risk. Lastly, we continue to partner and communicate with successful and experienced fund companies to help guide us, keep us abreast of developments, and offer investing strategies.
Now more than ever, it's important to know your risk tolerance and your investment time horizon. For those still saving for the future, continue to buy. Investing on a systematic basis takes advantage of dollar-cost-averaging, one of the most basic principles of investing. Have a plan and stick with it. If your goals have changed, it would be a good time to review your investment strategy. If you have money in the market that will be needed in the next 12-24 months for lump sum expenses, perhaps those monies should be withdrawn. Otherwise, stay invested and stay diversified.
The stock markets may temporarily rebound near year-end, but conditions may get worse overall before they get better. We are likely entering one of the most difficult periods seen in quite some time, so exercise patience. As stated by Warren Buffet, "The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people."
ARE SERIES I BONDS WORTH CONSIDERING?
One of our goals in publishing our client newsletter is to inform clients. In doing so, we attempt to address current events and news headlines. On May 5th the U.S. Treasury announced the latest composite rate on Series I savings bonds of 9.62%. With such an eye-catching rate, we want to pass along information on these bonds to help you better understand them and determine if they are a good choice for you. As is the case with any investment, there are advantages and disadvantages to consider. In the end, suitability depends on your goal and the purpose of the account.
Like Series EE savings bonds, I bonds are issued by the U.S. Treasury. A Series I savings bond earns interest based on both a fixed rate plus a rate based on inflation that is set twice a year. The bond earns interest until it reaches 30 years or you cash it, whichever comes first. You will know the fixed rate of interest when you buy it. The current fixed rate, which never changes, is 0%. The inflation rate, which can change every six months, is set on the first business day of May and on the first business day of November. The inflation rate is based on changes in the non-seasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items, including food and energy. Currently, the semi-annual inflation rate is 4.81%. To determine your actual (composite) rate, you combine the fixed rate and the inflation rate. Currently, for the first six months you own it, the Series I bond, if purchased from May 2022 through October 2022, will earn interest at an annual rate of 9.62%.
Series I bonds must be purchased online directly from the U.S. Treasury. You can purchase them in any denomination of $25 or more but can only purchase up to $10,000 (per Social Security number) per calendar year. Unlike Series EE bonds, you pay the face value of the bond. The interest earned is subject to Federal income taxes but not state or local taxes. Though taxable, you can choose to report the interest every year as it is earned or defer reporting the interest until you cash the bond or it matures. In all cases, the interest accrues or is reinvested. Therefore, this is not an ideal vehicle for someone who wants to use the interest for monthly income.
Remember, Series I bonds are 30-year bonds. You're able to cash them after the first year. However, if you cash them within the first five years, you lose the previous three months of interest. Also remember that the current rate of 9.62% will change. As inflation comes down, so will your rate. Therefore, Series I bonds are likely best used as an temporary alternative for part of your emergency reserves/savings account balances and not for your longer-term investments or core savings. For complete details on Series I bonds, visit the Treasury's website at www.treasurydirect.gov.
SECURE Act 2.0 – PENDING LEGISLATION FOR RETIREMENT SAVINGS
In December 2019, the "SECURE Act" was passed that made changes to retirement savings. One of the changes with this legislation was to extend the required minimum distribution ("RMD") age for IRAs from 70-1/2 to 72. In March of this year, the House passed SECURE Act 2.0, bringing more changes to retirement savings. The bill was passed on to the Senate but had taken a back seat to the President's infrastructure bill.
Some of the changes in the House's version include raising the RMD age again from 72 to 75, automatically enrolling workers in their company's retirement plan, allowing employersponsored plan participants to designate employer matching as Roth contributions, providing more generous tax breaks to small companies that establish retirement plans, and increasing the catch-up contributions on SIMPLE IRAs for people between ages 62 and 64.
On June 14, 2022, the Senate Health, Education, Labor, and Pensions Committee approved its version of SECURE Act 2.0 and is calling it the Retirement Improvement and Savings Enhancement to Supplement Health Investments for the Nest Egg ("RISE and SHINE") Act. However, they have made changes to what the House proposed, one of which was not to increase the RMD age. The Senate Finance Committee anticipates releasing its retirement reform bill by July 4. The expectation is for the Finance Committee bill and the HELP Committee bill to merge into a final bill, which the Senate will vote on later this year. The Senate bill will then be reconciled with SECURE Act 2.0, and both chambers will vote on the combined bill. As always, we will pass along updates on this legislation in our next newsletter due in January 2023.
UPDATE ON THE ACQUISITON OF TD AMERITRADE BY CHARLES SCHWAB
As a reminder, the integration of TD Ameritrade into Charles Schwab has begun with final conversion scheduled for September 2023. It is likely no action will be required by our clients. TD Ameritrade and Schwab are anticipating the conversion will be a paperless one and that no paperwork should be needed. Eventually, we will see changes to account numbers, statements, and the client website. However, you will not see any changes in the service and advice we provide to you.
n the meantime, if you have opted to receive statements electronically instead of by paper every month, be sure your access to TD Ameritrade's website at www.advisorclient.com is active. If you're not set up and would like to be or have any other questions, please call our office.
Sources for All Articles: T. Rowe Price; CNBC; Capital Group/American Funds; Marketwatch; U.S. Treasury; National Law Review.
Disclaimer: The opinions expressed herein do not necessarily reflect those of Trustmont Financial Group/Trustmont Advisory Group. Additionally, the information contained herein has been obtained from sources believed to be reliable but the accuracy of the information cannot be guaranteed. Lastly, reference to any product, service or concept in no way implies that it is suitable for everyone. There may also be risks and costs associated with any product, service or concept mentioned herein. Where applicable, a prospectus should be read for complete details. The material presented here is neither an offer to sell nor a solicitation of an offer to buy any securities.