Windsor Brief for December 2022
Investing:November Brought Inflation Relief
Planning:Year-End Financial Checklist
This month’s Windsor Brief discusses November’s strong market performance, what drove it and what may lie ahead.
In our Financial Planning section this month we look at a year-end financial checklist. We don’t want you to miss out on allowable contributions or required distributions.
If you’d like to talk to us further about these topics or about any of your financial planning or investment goals, please do not hesitate to get in touch.
Investing: November Brought Inflation Relief
November was one of the few months this year where both the equity and fixed income markets delivered positive results. This was also the first positive back-to-back months for the S&P 500 since August of 2021. The S&P 500 produced a total return of 4.81% while the fixed income market, represented by the US Aggregate, returned a positive return of 3.24%.
After a difficult couple days to start to the month, the market experienced a nice rally of 9.89% from November 3rd till the end of the month. The main driver of the rally came on November 10th, when the CPI (inflation) number was reported. The reported number came in lower than expected, an indicator that inflation had peaked and is beginning to subside. We have frequently mentioned in past Windsor Briefs that the leading inflation indicators were clearly showing inflation was slowing, but we have been patiently waiting for it to actually show up in the reported CPI numbers and it finally arrived. This news sparked a strong market rally, as it showed the higher interest rates are having the desired impact on consumer demand. This gives the Fed breathing room on their crusade against inflation. However, the Fed has been very clear since that report that they are staying vigilant on fighting inflation, and we should expect them to continue to raise rates into 2023. As a matter of fact, FedChairman Powell gave a speech November 30th indicating the Fed will continue to raise rates until inflation is fully under control, though they are seeing positive signs develop on inflation, giving the market a nice boost the final trading day of November. As the market is always forward looking, it has already discounted future interest rate hikes into its outlook. The key here is with the Fed gaining some breathing room, the market does not expect the Fed to be more aggressive than what is already expected and priced into the market. As shown on the graph below of the Federal funds rate (interest rates), the consensus forecast and market implied forecast both are similar (even a bit more aggressive) to the Fed forecast through 2023.
Federal Funds Rate - Upper Bound (%)
We will get the November CPI report on December 13, and both the market and the Fed will have a laser focus on the results. If the inflation number comes in lower than expected once again, this will be very clear evidence that inflation peaked in September and interest rate increases will begin to moderate.
Looking at leading inflation indicators, as before, all evidence implies inflation has indeed peaked and we should see a continued drop in the CPI number. Looking at the supply chain, lead times are down, delivery times are down, shipping costs are down, raw material inventories have increased and the backlog of orders has dropped. All are indicative of slowing inflation.
Supply Chain Improvements: Lower Inflation Ahead
More importantly, we see increasing evidence of lower rent inflation ahead, one of the stickier components of inflation. As a reminder, CPI is a backwards looking indicator and not indicative of what is happening in real time. In the chart below, you can see the Zillow Rent Index, which leads the rent component of CPI by about 6 months, has begun to pull back dramatically, another indicator inflation will continue to moderate going forward.
U.S. CPI Rents Year over Year vs Zillow Rent Index Year over Year
We are also beginning to see evidence that employment is slowing, with rising unemployment and declining job openings, another positive sign that inflation is beginning to come under control. We will get important job-related data on December 2nd that will give further insight to what the labor market is experiencing.
Lastly, if you look at historical precedent, inflation tends to be quite symmetric to the upside and downside. In the table below, you will see that based on history, 16 months after peak inflation, the inflation reading averages approximately +0.5-1% higher than where inflation started its ascent 16 months prior to the peak. This cycle, the starting point was just below 2%. If inflation ends 2023 at 2.5-3.0%, that would be a significant accomplishment for the Fed. This would be slightly above their target, but the market would view this as a major victory.
U.S. Inflation is Mostly Symmetric Up/Down
In closing, November delivered a strong positive result in both the equity and fixed income markets. This result was driven by lower-than-expected inflation giving indications it most likely peaked in September. The inflation tea leaves provide compelling data that inflation should continue to wane going forward, giving the Fed confidence their actions are now having the desired impact. The next two weeks will see a plethora of data that will give further insight into inflation, starting December 1st with PCE (personal consumption expenditures), followed by employment data and ultimately CPI on December 13th. Aside from inflation, we will be closely monitoring the reduction in corporate earnings and the recession risk in 2023, both of which we think are under control and well understood at this time. As always, we will be seeking out opportunities for your overall financial plan based on the current economy and our outlook. Together, we will continue to tailor your plan to suit your uniquefinancial objectives and a risk level you are comfortable with. Thank you for your confidence in our team and in Windsor Wealth Management.
Planning: Year-End Financial Checklist
Don’t lose out for 2022! If you have any financial transactions that you need to have completed before year-end, the time to act is now. The first week in December is the latest to submit requests at many institutions to insure they have time to process by December 31st. The following are some of the more popular items that may be included on your financial checklist:
- 401k Contributions: Salary deferral contributions into 401k or 403b accounts need to be made by December 31st. The 2022 employee deferral limit is $20,500 ($22,500 for 2023). Individuals age 50 and older can make an additional $6,500 catch up contribution ($7,500 for 2023).
- IRA Contributions: 2022 IRA contributions of $6,000 plus $1,000 catch up can be made up until April 15th next year. IRA contribution limit increases to $6,500 for 2023 ($1,000 IRA catch up unchanged). Windsor can help you determine if you are eligible to make a deductible IRA contribution or a Roth IRA contribution.
- Conversions: A conversion from IRA to Roth IRA is taxable in the year you convert. If 2022 is a low-income tax year, then you will want to have the conversion completed by December 31st.
- Distributions: If you are subject to Required Minimum Distributions, the minimum amount must be distributed from your account by December 31st (unless you turned 72 this year and can delay your first RMD until April 1, 2023). New RMD rules are in place for individuals that inherited an IRA in 2020 and beyond. Please let us know if you have any questions regarding RMDs in your account.
Health Savings Accounts
- Contributions: Review your year-to-date funding and see if you can adjust your last paycheck contribution if needed or applicable. The 2022 contribution limit, which includes employee and employer contributions, is $3,650 for individuals ($3,850 for 2023) or $7,300 for family coverage ($7,750 for 2023). Age 55 and over can make an additional $1,000 contribution (does not adjust for inflation). Direct non-payroll contributions can be made up until April 15th.
- Contributions: Indiana 529 contributions must be received by the plan by year-end in order to claim the 20% Indiana income tax credit. For 2022, the maximum annual credit per single/joint tax return is $1,000 (20% of a $5,000 contribution). For 2023, the new maximum credit will be $1,500 (20% of a $7,500 contribution). Please let Windsor know if you are a resident of a different state and would like to learn about any available state tax deduction or credit.
- Distributions: Must be taken in the same calendar year that the qualified educational expense is paid. If you paid an education expense in 2022, you must take the 529 Plan reimbursement distribution by December 31, 2022. If you are going to pay the expense in January 2023, then you need to wait and request the distribution in 2023.
- If under age 70 ½, consider transferring shares of low basis investments. The date the charity receives the contribution is the year in which you can claim the deduction.
- If you are over age 70 ½, then you can make a Qualified Charitable Distribution directly from your IRA of up to $100,000 per year. The QCD will not be taxable and can be used to satisfy your Required Minimum Distribution thereby lowering your taxable income for the year. Keep in mind that the charity must receive the distribution by year-end.
- The annual gift tax exclusion amount is $16,000 for 2022 (increasing to $17,000 for 2023). This is the amount you can give each recipient without paying gift tax or using part of your lifetime exclusion amount.
Please let your Windsor advisor know if you have any questions regarding any of the above checklist items. Time for implementation is now!
Dream boldly. Plan wisely.