Windsor Brief for June 2022
Investing:Political Influences in the Markets
Planning:Financial Planning Strategies During Periods of Increased Volatility
This month’s Windsor Brief looks at the impact politics have on the equity markets. From a mid-term election year, to Ukraine, to the shift in fiscal policy, all these factors play a part in the market outlook.
Our Financial Planning section this month discusses financial planning opportunities to employ during periods of increased market volatility.
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: Political Influences in the Market
The stock market is like a living entity. In its collective totality, it receives information in and processes this information to develop assumptions and make decisions. Every little piece of information is collected and pieced together in an overall mosaic that will dictate market outcomes. This information includes items such as current economic data points, consumer sentiment, company earnings, IPOs, mergers/acquisitions, or even historical precedent. Political events are often a large contributor to the source of information a well, especially in 2022.
There are many different political drivers impacting the markets currently. As mentioned in prior Windsor Brief’s, this year is a mid-term elections year, which typically has a pattern associated with it. As shown in the chart below, the market tends to be negative with volatility in the first half of the year. The market then regains its footing in October and tends move upward through the remainder of the year and beyond.
Average S&P 500 Performance Before and Following Midterm Elections
Although we have not seen the exact pattern shown above, the markets this year have clearly been volatile and negative, following the overall trend seen in the past mid-term election years.
Looking for similarities, 1982 is a very interesting mid-term elections year. In 1982 the US was dealing with not only the elections, but inflation (that had already peaked but was still about 7%) and Russia. As a refresher, Russia had invaded Afghanistan in 1979. In response, the US boycotted the Russian Olympics in 1982 while Russia boycotted the US Olympics in 1984. Thus, similar types of political events taking place to 2022. As shown below, the stock market is mimicking 1982 closely, though has gone down a bit quicker than in 1982.
S&P 500 Price Returns: 1982 Vs. 2022
Source: Windsor Wealth Management and Bloomberg
Another interesting comparison that ties into the political landscape is the year 1970. In 1970 the country was experiencing similar political situation today with it being a mid-term election year, high inflation, rising energy costs due to the OPEC embargo and an ongoing war in Vietnam. As shown in the chart below, this year is tracking very similarly to 1970. Some market pundits view 1970 as a road map for 2022 due to the very similar political issues taking place.
S&P 500 Price Returns: 1970 Vs. 2022
Source: Windsor Wealth Management and Bloomberg
There are other political events that are helping to shape the markets in 2022. For instance, we are undergoing the largest reduction in US Federal budget deficit since World War II.
Reduction in US Federal Budget Deficit (as a % of GDP)
What is driving this historical reduction? It is a combination of a significant drop in government spending on Covid-19 relief and other injections of cash into consumers hands along with a significant ramp up in federal tax revenue collections driven by capital gains taxes. These shifts have implications on GDP and the economy longer term.
In addition, on the spending front, the Build Back Smaller plan is gaining some traction. Although it is not totally clear at this point if it can pass and what it would ultimately look like, we can see the framework from where they are now starting, with both the spending and the taxes to pay for the spending. How this ultimately shapes up will have lasting impacts on the markets, particularly for multinational, energy, and healthcare companies.
What a Revised Build Back Smaller Plan Could Look Like
There is currently a budget reconciliation window open in Congress, which will allow new spending to be passed with just 51 votes. There has never been an example where Congress opened a budget reconciliation window and failed to use that reconciliation power. Thus, it is expected something will get passed by September 30th. It could be Build Back Smaller mentioned above. But there are other possible outcomes depending on how the political winds blow. Below are four possible options that could get passed using this reconciliation window.
If BBS fails, congress may move to a Healthcare only package
Any of the above options, or a derivative thereof, will have impacts on investors and the markets. Thus, it is important to continue listening for what is coming out of Washington D.C. and the policies that can impact the markets longer term.
Last, fiscal policy, monetary policy and the war in Ukraine have had negative impacts on inflation. However, there are some possible signs of light at the end of the inflation tunnel. For example, many industrial commodity prices are actually down year over year. As this chart from IHS Markit shows, only Fiber and Energy are higher year over year while iron, lumber, rubber, pulp, and others are down. Although not shown in the graph, even industrial metals like copper and platinum are down year over year.
Movement in Price year over year
Source: IHS Markit and Fundstrat
Morgan Stanley is now suggesting that the chip shortage for automobiles may be improving as chip shipments have been ramping up. Improved availability combined with slowing auto demand would put pressure on new and used car pricing. In addition, a recent CNN article highlighted the increasing inventory at retailers may require discounting. “Target, Walmart, Best Buy, Urban Outfitters, and other top retailers have said in recent weeks that they are sitting on too much inventory for some of their products. As a result, they plan to mark down prices and step-up sales on those items.” This is a significant change from most of 2021. Finally, though there is not a lot of detail on this yet, the WSJ reports that OPEC could exclude Russia temporarily and pave the way for OPEC to increase production. Per the WSJ, “exempting Russia from its oil production targets could potentially pave the way for Saudi Arabia, the United Arab Emirates and other producers in OPEC to pump significantly more
crude”. This would help curtail the rising oil prices. Inflation remains high, but there are hopeful signs of potential relief on the horizon.
In summary, the markets absorb all possible information, including political information and historical precedent. This information is used to create a mosaic that drives the direction of the market. There are many winds and currents impacting the markets in 2022, and we continue to closely monitor this information and how it may impact investing decisions into the future.
Planning: Financial planning strategies during periods of increased volatility
Market volatility is unfortunately a part of investing for the long term. It is important to not try to time the market during these periods and to remember the familiar quote “it is the time in the market that matters.” Windsor may use these times of market volatility to discuss the following financial planning strategies:
- Tax Loss Harvesting – Realizing current capital losses by selling out of an investment and then purchasing a similar but not identical investment within the same asset category. The IRS has rules against repurchasing an identical investment (Wash Sale Rules) which would cause the loss to be disallowed. You can utilize a capital loss to offset current year capital gains plus up to $3,000 of ordinary income on your tax return. Any additional unused amount will carry forward each year until the total capital loss is utilized.
- Rebalancing – Different asset categories will rise and fall at different times or different intensities. It is important to rebalance back to your target asset allocation. If your portfolio strays too far from your target allocation, it could end up containing a higher degree of risk then you are comfortable with. In addition, rebalancing could mean buying asset categories that are at a bigger discount and may be considered “on sale.”
- Roth Conversions – A Roth Conversion involves a taxable transfer from an IRA account to a Roth IRA account. When the market is down, you may be able to transfer the value of your investments at a lower tax cost.
- Gifting – If you are gifting securities to family members, you may be able to gift more shares while keeping within the annual gift tax exclusion amount ($16,000 for 2022). Same theory applies to gifts beyond the annual exclusion amount also if you are considering making larger gifts. The future appreciation/recovery value of the security is removed from your estate.
- Distributions – If you do not need the current cash flow, you may wish to temporarily lower discretionary portfolio distributions.
- Contributions - Save more and invest during the market downturns if possible. It is generally a good time to invest when the market is down. We do not recommend putting your Emergency Fund at risk, however, if you have additional cash on the sidelines you may wish to consider if these additional funds are available for investing for the long-term.
While market volatility is not enjoyable, employing some of the strategies above may provide larger long-term benefits. Windsor would like to help you keep your focus towards your long-term goals including during times of market volatility.
Dream boldly. Plan wisely.