Windsor Brief for March 2022
Investing:Deciphering the volatility
Planning:2021 IRA Contributions
This month’s WindsorBrief discusses the market action in February, current events taking place and the impacts of these events on the markets going forward. On a personal level, we want to recognize the terrible events and human suffering that is taking place in Ukraine and continue to hope for peace and a quick end to the conflict. With that being said, we must put on our analytical hat to provide our WindsorBrief below.
Our Financial Planning section will focus on the different types of IRA contributions, and which may be right for you.
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: Deciphering the volatility
February delivered another month of increased volatility. The month started strong, continuing the rebound from the lows of January. However, as the month progressed concerns on the pace the Fed would be increasing interest rates began to impact the equity markets. The market pullback then accelerated with heightened concerns of an impending invasion of Ukraine by Russia. Although this pending invasion sparked concerns in the stock market, the concerns from these types of events are normally short lived. As a matter of fact, in the prior five military “invasions” that have taken place, the market rallied on the actual invasion itself and was a buying opportunity.
5 of 5 Times: Stocks Bottom Just Before "invasion"
6 months prior (2 months prior shaded in gray) and 18 months after
(Note: the 2002 period post the Afghanistan invasion bounce was impacted by continued market weakness from the internet bubble as well as the impending Worldcom bankruptcy, and several other corporate accounting scandals). We have mentioned historical precedent in these briefs before. And with these prior 5 invasions as precedent, the market opened significantly down on the day of the invasion of Ukraine, and finished up very strong, with solid follow through the following day.
30 minutes, past month
Source: Fundstrat and Bloomberg
We expect the market to remain volatile as the Ukraine situation plays itself out, as it is entirely unclear how this conflict ends, especially as it looks like Russia may be about to begin a major offensive. As one would expect, the better the news and the quicker the resolution, the better for the market, and for the world. In general, geo-political events are often longer-term buying opportunities.
S&P 500 Performance Around Select Geo-Political / Military Events
But why did the market reverse the day of the actual Russian invasion into Ukraine, in what seems to be a terrible geo-political event? There are several reasons to explain the market reversal and why the markets could finish in positive territory this year. First, the markets had been entering oversold territory and just needed a final capitulation move to get there. The market drop the day of the invasion into Ukraine was that spark, forcing this capitulation and the resulting rebound. But more importantly, concerns that the Fed would be raising rates 50 basis points (1/2%) in March greatly receded with the increasing geo-political tensions. The market expectations now are for only one increase of 25 basis points (1/4%). This lowered interest rate expectation was the perfect medicine for the beleaguered market. The chart below shows the World Interest Rate Probabilities (WIRP). This chart shows that as of February 11 the expectations were for two hikes in the month of March, but that
expectation has fallen to essentially only one interest rate hike now.
Source: Fundstrat and Bloomberg
More importantly, despite how horrible the events in the Ukraine are, the implications in the United States are relatively minor. We may experience a temporary bump in already elevated gasoline prices and some commodity costs, but this should be temporary. While it could slow the U.S. economy it should not be significant enough to derail the strong economy. As a reminder when you look at the various economic indicators, the U.S. continues to be quite strong. As shown in the graphs below, whether you look at home prices remaining strong, unemployment near all-time lows, consumer net worth at all-time highs, or restaurant reservations continuing to recover from the pandemic, the economy is still growing.
Case Shiller Home Price Index, U.S. Consumer Net Worth, Labor Force Participation Rate, Restaurant Reservations
In addition, we are almost through the Q4 earnings reporting season, and 77% of companies surprised to the upside when they reported earnings, a strong showing indeed. Likewise, sanctions on Russia will have limited impact on U.S. companies as revenue exposure to Russia and/or Ukraine, are very limited, as shown in the chart below.
Companies With Exposure to Russia and Ukraine (excluding Russian companies)
Source: Citibank estimates, Bloomberg, company reports
There could be some minor implications for companies with exposure to Germany, as their economy may slow from increasing energy prices, but once again, this is not a significant impact to the overall U.S. economy.
In addition, there appears to be some relief to inflation on the horizon (notwithstanding the expected near-term impact from Ukraine). If this data continues to show inflation will pull back, this will give the Fed more cushion and reduce the need for extensive interest rate increases. The figure below from DeepMacro shows the inflation factor for the U.S. The inflation factor shows the “common driver” of inflationary pressures across all segments of the economy (not just the final demand, or consumer stage). The inflation factor peaked in November of 2021. By segment, inflationary pressure at the consumer level continues to accelerate, and this is important because it is, after all, what the Fed targets. It is also a lagging indicator. But pressures at the producer level, at the foreign trade level, and among inflation and price sentiment and expectations measures (such as market derived long-term breakeven inflation rates, and corporate surveys) have retreated slightly in the last few months. If this trend continues, peak inflation could be behind us, but we will have to wait and see how the geo-political world events impact this in the near term. Note the purple, orange, and red bars both flattening and turning down slightly in the graph below.
United States Inflation Factor, March 2017 - February 2022(Std. Dev. from 10-yr mean)
Investing is never an easy ride. But it is important to remember that the market is nearly impossible to time and the best strategy it to stick to your investment plan and do not panic. As the chart below shows, since 2002, seven of the best days in the market occurred within 15 days of the ten worst days.
It's Always Darkest Before Dawn
Source: JP Morgan
The long-term performance of the stock market is up and to the right, despite some volatility along the way. The market always seems to recover from these disruptions, regardless of the type or magnitude.
S&P 500 With Major News Stories
1928 - 2022
Do not hesitate to contact us if you would like to discuss this commentary or your portfolios. We realize this has been a challenging start to the year and want to make sure you feel comfortable in your financial outlook.
Planning: 2021 IRA Contributions
Documents are being gathered and 2021 tax returns are being prepared. As you review your return, you may be deciding if an IRA contribution can be made. And if so, what type? The following are some of the key requirements for 2021 IRA contributions.
- Contribution Deadline: April 15 for a prior tax year contribution
- 2021 Maximum Contribution to all IRAs combined: earned income up to $6,000 (plus an additional $1,000 catch up contribution if age 50 and older). Amounts unchanged for 2022.
- You must have earned income in order to make an IRA contribution. A spousal IRA contribution can be made into a non-working spouse’s IRA if the working spouse has enough earned income.
Deductible Contributions: A Traditional IRA funded with deductible contributions – you get the tax deduction up front, and earnings grow tax deferred. Distributions will be fully taxable. The Traditional IRA with deductible contribution is advantageous if you are in a high tax bracket now and expect to be in a lower bracket later. Your ability to make a deductible Traditional IRA contribution may be limited based on your income. The following limits apply:
- If you and your spouse are not covered by a retirement plan at work, no income limit
- If you are covered by a retirement plan at work, the IRA deduction is no longer allowed for Modified Adjusted Gross Income above the following:
- Single $76,000
- Married Filing Jointly: $125,000
- Married Filing Separately: $10,000
- Non active participant married to active participant, income limit $208,000
Nondeductible Contributions: There are no income limits to make a nondeductible Traditional IRA contribution. If the Traditional IRA is funded with nondeductible contributions, this is considered tax basis in the account and will need to be tracked on IRS Form 8606. Future distributions will be taxed pro-rata based on the tax basis in the account. A tax efficient brokerage account may be a better alternative for this nondeductible savings.
One reason you may wish to make a nondeductible IRA contribution is if you are planning to make a back door Roth IRA contribution (nondeductible IRA contribution followed by a Roth conversion). In general, there are two conditions for making backdoor contributions: your income is too high to make a Roth contribution (see below) and you do not have any other pre-tax IRA accounts. If you meet both of those conditions, then a back door Roth IRA contribution may be a good option. Note this strategy was to be banned in the 2021 Build Back Better legislation but that law failed to pass last year in Washington.
A Roth IRA is funded with nondeductible after-tax contributions. Earnings grow tax free and qualified distributions are not taxable. In general, the Roth IRA is advantageous if you are in a lower tax bracket now and expect to be in a higher bracket later, or if you want tax diversification in your retirement accounts. The ability to make a Roth IRA contribution is disallowed once Modified Adjusted Gross Income reaches the following:
- Single: $140,000
- Married Filing Jointly $208,000
- Married Filing Separately: $10,000
There are many factors involved in deciding whether to make IRA contributions and if so, what type. We have covered some of the key factors above. Distribution requirements from the IRA accounts also have different requirements depending upon the type of account and type of contribution. Windsor will be happy to help you sort through the differences and determine what type of contribution would be advantageous in achieving your goals. Windsor will also continue to monitor changes that take place in Washington and how those changes will affect your financial plan.