Windsor Brief for February 2022
Investing:Looking Back and Looking Forward
Planning:Qualified Charitable Distributions
This month’s Windsor Brief looks back at the volatile start to 2022 and digests what took place. In addition, we look forward to what this may mean for the rest of the year and look at historical data for some precedent to what the future holds.
Our Financial Planning section will focus on qualified charitable distributions and how this may be a good tax-efficient way to make charitable gifts.
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: Looking Back and Looking Forward
The first month of 2022 entered like a bear and reintroduced investors to the concept of volatility while at the same time delivering the worst performance for the month of January since 2009. The -5.26% return was also the third worst January since 1990. On a positive note, the market finished nicely off the intra-month low of -11.05%.
Although periods of disruption and market dislocation are difficult to endure, it is important to remember that this is a normal occurrence that happens frequently. 2021 was an anomaly, as it was a year which never experienced a pull back of over 5%. This has only happened two other times in the past 34 years, in 2017 and 1995.
S&P 500 largest intra-year drawdowns
Source: Strategas and Windsor Wealth Management
The increase in volatility to start the year was driven by several factors: inflation concerns, interest rates, geo-political tension and to a lesser extent the Omicron variant of Covid-19. Although these issues remain today, the Fed has recently given more clarity on what the market can expect in terms of interest rate increases (expectations are for five increases of 0.25% each in 2022). Inflation remains high, but there are indications it could subside somewhat as we go through the year. Omicron cases have begun to roll over and this wave appears to be subsiding. The geo-political tensions remain an unknown, but hopefully can be resolved diplomatically. Although all the above issues are still present, the markets have had time to digest and understand these issues as we went through the month, providing a bit of relief. Uncertainty breeds fear in the market, while certainty calms these fears.
Unfortunately, there is no crystal ball for investing, but using a mosaic approach is the next best thing. One of the many pieces of that mosaic is the internal technicals of the market while another piece is using historical data to understand how the market reacts to certain environments. This historical data often gives us a better understanding of where the markets could go in the next 3-, 6-, and 12- month periods. But first, let’s look at one important technical chart of the S&P 500. In this chart, you can see the market set a low of 4,222 on January 24th, declining 11% from the earlier all-time high. From that point on, it built a very strong “base” at 4,300 from which it did not go below. After forming that base for several days, the market has now bounced nicely off that level, ending the month at 4,515.
S&P 500 January 2022 (through 1-27-22)
Looking at historical data, the American Association of Individual Investors (AAII) % bulls less bears sentiment reading is one of the leading sentiment indicators followed by Wall Street. As shown below, we reached a reading of -29.8 on January 27, 2022 which is lower than we saw during the Covid-19 pandemic in 2020. In the second chart below, you can see this is one of the 5 most bearish readings since 2008.
AAII % Bulls Less Bears 1-1-20 to 1-26-22
Source: Bloomberg and Fundstrat
AAII % Bulls Less Bears 2008-2022
Source: Bloomberg and Fundstrat
Digging deeper into this AAII data shows some interesting historical patterns.
1. 5 out of the 6 times this indicator has dropped below -28 since 2008, the market was up the next 1-month period.
2. 6 out of the 6 times this indicator has dropped below -28 since 2008, the market was up the next 3-, 6- and 12-month periods.
S&P 500 Forward Return...
As shown in the table above, the stock market tends to go up in the 1-, 3-, 6-, and 12-month periods following the AAII sentiment reading breaking the -28% level. In other words, the sentiment is so bad, that it is a positive. Once again, we do not know what will happen this time, but historically, this has been a positive indicator for the market. This data combined with technical analysis, an example being the the chart above showing the market “base” last week, and the fact that the economy remains strong, gives comfort that this pullback is a typical pullback the market experiences from time to time and not a change in the overall trajectory of the market. It is still early in the year, but hopefully this volatility driven by inflation, interest rate, geo-political, and Covid concerns will continue to subside as the market refocuses back on strong corporate earnings and a continued robust economy.
Planning: Qualified Charitable Distributions
The beginning of the new year means it is time to develop a game plan for 2022 cash flow. For many seniors, that process involves calculating your 2022 Required Minimum Distribution from qualified accounts. Windsor will help you calculate the amount that needs to be withdrawn each year. Once that RMD amount has been determined, the next question is: Do you plan on making any charitable gifts this year? If yes, a Qualified Charitable Distribution may be a good tax-efficient way to make charitable gifts.
A Qualified Charitable Distribution (QCD) is a distribution from an IRA made directly to a qualified charity. The QCD can be used to offset your RMD amount and lower your taxable income. It gets money out of an IRA at no tax cost. The following are some of the requirements:
- The IRA owner must have attained age 70 ½ (this did not change to new RMD age of 72)
- Allowed from IRAs or Inherited IRAs (but not allowed from 401k or company retirement plans)
- Distribution must be made directly to a qualified charity (check needs to be payable to the charity but can be mailed to you to deliver to the charity)
- Qualified charity does not include donor advised fund or private foundation
- The IRA owner cannot receive any benefit in return for the charitable donation
- Annual maximum $100,000 per year per IRA owner
The QCD amount cannot be claimed as an itemized deduction on your tax return – however, fewer people itemize due to the larger standard deduction. By making a QCD, you would still be receiving a tax benefit since the QCD is excluded from income. In addition, since your Adjusted Gross Income would be lower, you may receive additional benefits such as lower Medicare premium surcharges or additional availability of deductions or tax credits that are based on AGI.
As a planning note, all IRA distributions are currently reported in total on the custodian’s Form 1099-R. It is up to you to keep track of how much of the reported distribution is taxable income and how much is non-taxable QCDs.
Windsor would be happy to assist you with your 2022 cash flow plan and help you determine if you are eligible to make a Qualified Charitable Distribution.