Windsor Brief for September 2023
Investing:Will September Bring Relief?
Planning:401k Contributions Update
This month’s Windsor Brief reviews market performance for the month of August. In addition, we provide a brief overview of our outlook for September and into the rest of the year.
In our Financial Planning section this month, we are highlighting another IRS announcement made in August. This announcement will affect high income earners making contributions into their 401k plan. See our Financial Planning section below for more details.
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: Will September Bring Relief?
August brought an end to the string of positive monthly returns in the equity markets. As we highlighted in last month’s Windsor Brief, August is historically a tricky month for the market, and this year proved that out. Fortunately, the market did have a nice rally towards the end of the month, reversing a large portion of the market pullback. For the full month, the S&P 500 delivered a total return of -1.59%. For the year-to-date period the S&P 500 total return is still up a very solid 15.94%. The fixed income markets continued to struggle in August, following the same trajectory as the equity markets. The AGG, though well off its lows for the month, finished with a total return of -0.64% for August and is now up 1.37% year to date.
The main driver of the negative returns in August was long-term Treasury rates. The yields, especially on the 10-year bond, rose steadily through the first three weeks of the month, before peaking with just over one week left in August. For reference, the 10-year yield reached its highest level since November of 2007.
Yield on the 10-year Treasury
Source: Bloomberg and Windsor Wealth Management
The increase in yields was driven by a resilient U.S. economy and concerns inflation may take longer to control. As rates rose, both equities and fixed income markets struggled. Once the rates peaked and began to ease, both equities and fixed income experienced a very nice positive reversal, though not enough to completely erase the prior weakness.
As we enter September, investors have once again begun to question the market strength for the remainder of the year. However, we remain cautiously optimistic for September and the remainder of the year as there are several reasons we think the markets will finish higher down the stretch. First, we did receive a positive surprise this week with employment numbers coming in light. The July job openings report reading was 8.8 million, well below the consensus expectation of 9.5 million. In addition, the number of job openings per available worker also fell. Then this morning we received data showing the unemployment rate unexpectedly rose to 3.8%. These are both important data points as these are indicative of a slowing economy and employment is specifically one of the items the Fed has been trying to slow.
Job openings absolute level and openings / available workers ratio
Source: FundStrat and Bloomberg
In addition, today’s report showed both the year-over-year and month-over-month increase in hourly earnings came below expectations. Another good sign wage pressure on inflation could be subsiding further.
Year-over-year percent change in average hourly earnings
Source: CNBC, U.S. Bureau of Labor Statistics
A second reason we remain cautiously optimistic is we fully expect inflation to continue slowing over the next few months. As we have mentioned many times in past Briefs, inflation data has a lag and takes time to find its way into the reported numbers. However, it is clear the real time data is slowing, and this is beginning to find its way into the CPI reports. Third, the Fed is near the end of the interest rate hike cycle. We would not be surprised to see one, potentially two, more increases. Regardless, the cycle appears to be very close to coming to an end. Fourth, with the recent market pullback, investor sentiment has once again become quite bearish, which is often a positive indicator of future returns. Make no mistake, there are still some clouds on the horizon that we are monitoring. The issue over the government shutdown in October will come to a head this month and could cause some consternation in the market. Likewise, data is somewhat unpredictable, and we could get an unexpected data point. But we believe if any of these types of issues pop up, they should be temporary and relatively inconsequential.
Overall, there are multiple reasons to remain optimistic on the market. There will always be volatility, but we expect the good news to outweigh any negative news as we peer into September and beyond. The economy remains healthy, is no longer overheating, and the Fed is in the home stretch of raising rates. This should be a good recipe for the market. 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 unique financial objectives and a risk level you are comfortable with. Thank you for your confidence in our team and in Windsor Wealth Management.
Planning: 401k Contributions Update
In 2023, the maximum employee elective deferral contribution is $22,500. The 2024 contribution limit will be announced in October, but it is expected that the contribution limit will increase only $500 to $23,000. Workers 50 and older can make an additional $7,500 catch up contribution in 2023 (projected not to change for 2024).
If the retirement plan allows, employee elective deferral contributions can be made as either as:
- Pre-tax contributions: contributions reduce your taxable income - you do not pay tax on the contribution amount; however, all future distributions will be fully taxable.
- Roth contributions: contributions are included in your taxable income, future distributions (including earnings) are not taxable.
As part of The SECURE 2.0 Act passed in December 2022, catch-up contributions made in 401k or similar plans by high income earners would have to be made as after-tax Roth contributions. This change was for contributions starting in January 2024. High income earners are defined as workers whose prior year wages exceed $145,000.
August 25, 2023 Update: The IRS realized that additional time is required to implement the new rule regarding catch up contributions. The IRS is providing an additional two-year administrative transition period for plans to make the necessary plan updates. Now this new rule must be implemented for catch up plan contributions starting in January 2026.
In general, when you are in a high tax bracket, it may be beneficial to make pre-tax contributions now in order to save on taxes. Then during retirement, your retirement distributions will be fully taxable, but you may anticipate being in a lower tax bracket.
The opposite holds true for after tax Roth contributions – you may be in a low tax bracket now and anticipate being in higher tax bracket when taking retirement distributions.
Some plans also allow for additional after-tax contributions that can be converted to Roth accounts. Your Windsor advisor can help you evaluate the saving opportunities available to you and help you plan your course for financial independence. Please let us know if you have any questions.