Windsor Brief for September 2022
Planning:Inflation Reduction Act
This month’s Windsor Brief discusses the recent market activity for the month of August, what were the drivers of performance and what this may mean for the future.
Our Financial Planning section discusses the Inflation Reduction Act which was signed into law on August 16, 2022. There are several provisions in this new Act that will apply directly to individuals, and we go through what this may mean 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: Déjà Vu?
The month of August was a bit of a roller coaster for the S&P 500 in terms of performance, ultimately finishing down 4.08%. The S&P 500 had a positive return of 17.7% from June 16th to August 16th. Unfortunately, the rally fizzled out and from August 17th to month end, the S&P 500 declined 8.05%. Although a slight pullback would be appropriate after such a run, this pullback was a bit larger than one would normally expect. What happened to cause this decline?
As we have mentioned multiple times in our monthly letters, the main market driver right now is inflation and the Fed. For various reasons, the market has struggled this year to anticipate the Fed’s reaction to inflationary readings. Through the first six months of the year, every time the market thought they knew what the Fed was contemplating for interest rate increases, it was surprised by a much more hawkish Fed. This hawkishness was driven by inflation that continued to rise quicker than anticipated which in turn required the pace of interest rate increases to accelerate. This ultimately drove the market to make a low on June 16th. It was then that the market and the Fed seemed to finally get on the same page for interest rate increases for the remainder of the year and beyond, resulting in the market rally mentioned above. Although the markets began to pullback slightly in mid-August after the 17.7% rally, a case of Déjà vu occurred on August 26th when Fed Chairman Powell gave a
speech in Jackson Hole Wyoming at the Economic Symposium. He had an unexpectedly hawkish tone in what appears to be an attempt to refute any doubt in the market regarding the Fed’s willingness and desire to continue to raise rates into 2023. This tone stands in contrast to the dovish sentiment expressed in the most recent Federal Open Markets Committee (FOMC) minutes. Once again, the market was caught off guard by the hawkish stance and the result was weakness in the stock market as it appears the Fed may be aggressive with rates for a longer timeframe than the market had expected which increases the prospect of a recession.
Despite the market weakness following Powell’s comments, we do not think much has changed in terms of the path of anticipated interest rates. Interestingly, the market implied year end Fed Funds forecast only increased marginally, unlike in June when Fed comments resulted in a 90-basis point increase.
Market implied year end 2022 Fed Funds rate
Source: Bloomberg, Windsor Wealth Management
In essence, there was no impactful shift from this speech in how the markets see Fed policy being conducted through year end. What has changed is there is now more speculation and uncertainty regarding how long the Fed will continue to raise rates and how long they will maintain rates at an elevated level. The market fully expects the next interest rate increase to be 50 – 75 bps, unchanged from prior to the speech. The market concern really is what occurs in 2023 and beyond. Overall, this was a Fed reinforcing the image they are serious about fighting inflation, and a stock market that reacted to the unexpected hawkish comments. The Fed remains committed to slowing the economy to bring down overall demand which should significantly curtail inflationary pressures in the system. But once again, the market and the Fed appear to remain on the same page when it comes to the path of interest rates going forward which should give the markets comfort over time as it grapples with the risk of a
recession from the interest rate cycle.
More importantly, as mentioned in prior Windsor Briefs, inflation continues to look as if it has peaked and is slowly coming down. It will take well into 2023 to get inflation levels back near the 2% range, but it appears we are on the right glide path. As shown below, the month over month CPI number in July was negative and was a dramatic drop from the prior two years, all of which have been positive. We would expect future month over month numbers to also remain subdued, leading to continued gradual drops in the annual CPI readings.
CPI: Material change in month over month CPI
Source: Fundstrat, Bloomberg
In conclusion, August was really the tale of two cities. The first half of the month experienced the continued positive market run that began in June. However, after approaching a nearly 18% bounce off the prior low, the market decided to take a rest in mid-August, giving back a little of the gain. Unfortunately, a very hawkish Fed speech resulted in a rapid drop the last five trading days of the month. This speech was really an attempt by the Fed to maintain credibility as inflation fighters and to prevent the markets from becoming lackadaisical in their view of the path of interest rates. Overall, the markets and Fed remain in alignment as the implied Fed Funds rate only moved up marginally post the speech and there is no real change to the outlook for interest rates. Inflation continues to moderate, and the economy remains relatively healthy. The main outstanding question the market is struggling with is how serious of a recession will we experience as a result of the interest rate
increases. Despite the recent market activity in August, we remain cautiously optimistic as we enter the last few months of 2022.
Planning: Inflation Reduction Act
On August 16, 2022, President Biden signed into law the Inflation Reduction Act (IRA). This Act contains several provisions for fighting climate change and reducing the deficit. A new corporate alternative minimum tax of 15% of financial statement income will apply to the biggest companies with income over $1 billion. Corporate stock buybacks will now be subject to a 1% excise tax.
The Inflation Reduction Act also contains provisions that will apply directly to individuals. These provisions are summarized below:
Health Care Related Provisions:
- Extends the Affordable Care Act enhanced premium subsidies through 2025 for people who buy insurance on the federal health insurance marketplace.
- Medicare Provisions for Part D Drug Coverage:
- Allows the Department of Health & Human Services to negotiate prices of some of the most expensive drugs purchased by Medicare beneficiaries starting with 10 drugs in 2023 (prices would take effect in 2026). Additional drugs would be added over the next few years.
- Starting in 2024, no more 5% payments required once out-of-pocket drug costs reach the $7,050 catastrophic threshold.
- Starting in 2025, capping Medicare beneficiaries out-of-pocket drug costs to $2,000.
- Limiting Medicare insulin cost sharing to $35 per month starting in 2023.
- Barring drug companies from raising prices faster than inflation starting in 2023.
- Premium hikes on Part D drug plans would be limited to 6% from 2024 through 2029.
Income Tax Provisions:
- Increase funding for IRS by $80 billion over 10 years for taxpayer services, operations, and enforcements. Treasury Secretary Janet Yellen directed that the increased IRS enforcement funds should not be used to increase audits for taxpayers with household incomes under $400,000.
- Clean Vehicle Credit/Electric Vehicle Tax Credit - must be largely sourced and manufactured in US effective immediately. No more vehicle cap per manufacturer starting in 2023.
- New Vehicle Credit - up to $7,500. The price of the vehicle (MSRP) must be below $55,000 for cars and below $80,000 for trucks and SUVs. In addition, the new car credit is not allowed if AGI over $150,000 single/$300,000 joint.
- Used Vehicle Credit - up to the lesser of $4,000 or 30% of sale price for used vehicles starting in 2023. The used car sale price must be $25,000 or less and the credit AGI requirement is under $75,000 single/$150,000 joint.
- Energy-Efficient Home Improvement Credits of up to 30% of the cost and $1,200 annual limit starting in 2023 (allowable credit based on project). Some energy efficient standards will be updated.
- Residential Clean Energy Credit of up to 30% through 2032 to install solar, wind, or geothermal systems to produce residential power.
- Alternative Fuel Refueling Property Credit up to $1,000 for equipment used to recharge an electric vehicle.
- High Efficiency Electric Home Rebates – provides rebates to low- and middle-income families who purchase energy efficient electric appliances. Families qualify if household income less than 150% of the median income where you live.
The above is a summary of the key individual provisions of the Inflation Reduction Act. As with all legislation, there are additional details and limitations provided within the actual law. Please let us know if you have any questions. Windsor will continue to keep you updated on new laws that may affect your financial planning.
Dream boldly. Plan wisely.