The Week in Review
Diversification Still Works
Debt Showdown Delayed
The Fate of Backdoor Roth IRAs (and More)
Fine-Tuning Your Medicare Coverage
Adviser Capital in the Media
Looking Ahead
A rocky month’s end for stocks and bonds on top of Capitol Hill’s muddled sausage-making has the news media once again breaking out its Chicken Little routine. But is the investment sky really falling this time?
Hardly. The S&P 500 was down 4.8% in September, its largest monthly decline since the pandemic went global in March 2020. But the index still squeezed out a 0.2% gain for the third quarter. Nothing to write home about, but also not a loss. Add in dividends—because dividends matter—and you get a 0.6% gain for the quarter. Tack that onto a 6.2% total return in Q1 and 8.5% for Q2, and the S&P 500 is up 15.9% in 2021. That’s 15.9% after the September slide.
We’re not going to tell you that stocks have finished falling (though they were rallying Friday afternoon as we were finalizing this update)—remember, in the average year the S&P 500 drops 14% from its high at some point in time. Maybe we’ll keep slipping through year-end; our Magic 8 Ball is cloudy. But we wouldn’t bet on it. Not only are the next three months historically the best calendar quarter for stocks, but we’re also seeing signs of economic relief and growth on the horizon: The delta variant seems to have peaked, this morning brought news of Merck’s promising new COVID-19 treatment and economists are indicating we may see a nice little bump in fourth-quarter growth.
That’s not to say we’re out of the woods. The holiday shopping season may be curtailed by snarled supply chains worldwide. Economists have dialed back estimates of third-quarter economic growth to around a 3% annual pace—a decent clip, but off from the more impressive (but unsustainable) 6% surge in both Q1 and Q2. Even with a 3% growth rate in the third quarter, the economy will still be around $360 billion shy of where it would’ve been had COVID-19 not disrupted life as we know it—and claimed 700,000 American lives in the process.
We remain sharply attuned to how every new development—be it economic, epidemiological or political—could impact your portfolios and financial goals. But just as important is maintaining proper perspective on long-term success and opportunities while ignoring the short-term noise that often rattles both Wall Street and Main Street.
Diversification Still Works
The financial media is more incentivized to grab eyeballs and claim clicks than deliver facts in proper context. Take just two headlines we saw in The Wall Street Journal yesterday: “Stock Market’s September Slump Exposes Messy Underside” and “In Bond Market Rout, Investors See Overdue Correction.”
“September slump”? Sure, as noted, the S&P 500 index fell 4.8% in the month. (However, keep in mind that when you include dividends, we still haven’t seen the S&P 500 fall 5% from the record high set on Sept. 2.)
But “messy underside”? Please. Any time you look under the market’s hood, some sectors will be doing better than others. It’s routine for 50% or more of the S&P 500’s stocks to be trading well below their normal highs—and therein lies the opportunity for active managers.
As for a bond market “rout,” okay, the yield on the 10-year Treasury bond has increased from 1.30% at the start of September to 1.51% at month’s end. (Remember, bond prices fall as yields rise.) That translates into a full-month decline of just 0.9% for a broad index of investment-grade U.S. corporate and government bonds. Not a win for sure, but a rout? Not in our book.
Yes, both stocks and bonds fell in September. That’s unusual but not unheard of. Does that mean diversification is broken? Absolutely not.
Looking back at the 417 months since the 1986 launch of a Vanguard fund that tracks the U.S. bond market, there have been just 54 months when both stocks and bonds fell at the same time. Most of the time when stocks fell, bonds rose. It’s not a guarantee, but then again, the historical record is compelling.
Diversification becomes more reliable as you extend your time frame. If you look at rolling three-month periods, only 28 (or 7%) of them saw stocks and bonds in the red at the same time. And only in two of the 406 rolling 12-month periods from 1986 through 2021 did stocks and bonds decline simultaneously.
Diversification isn’t broken or even bent. We recommend taking headlines suggesting otherwise with a few grains of salt.
Debt Showdown Delayed
Speaking of hyperbolic headlines, lawmakers were able to kick the can down the road to December to avert a government shutdown. Still, the high-stakes game of chicken continues over raising the federal debt ceiling—without which the country will default on its bills.
Frankly, we find the debt-ceiling debates to be an unnecessary and dangerous game. Congress has the power of the purse—it dictates how much the government will spend on everything from the military to social services. Once that spending is set, there are two ways the government can pay for it: Collect taxes or borrow the money (also known as issuing debt).
When members of Congress set the budget, they know full well that meeting their spending plans will require the government to borrow money. But when we approach the debt ceiling, they turn around and tell the government not to borrow!
It puts the Treasury in the tough spot of having to defy Congress—either don’t spend the money Congress has authorized the Treasury to spend or borrow the money without congressional approval.
The Treasury has a few levers it can pull to buy Congress time as it sorts out which directive to follow—a government shutdown is a pretty extreme measure, but one that has been used several times in recent decades.
Of course, a shutdown is very different from a default. We can’t know for sure what impact a U.S. government default would have. It certainly would put at risk our ability to borrow at rock-bottom yields and our enviable position as the world’s reserve currency. And then there’s the “individual impact” to consider. For example, what happens to the nearly 50 million seniors whose Social Security payments would be impacted?
Both sides of the political aisle have acknowledged the devastating impact a default could have. While there’s likely to be partisan rancor and legislative horse-trading in the weeks ahead, we can’t believe that Congress won’t find a way to avoid defaulting on our obligations.
If you find yourself preoccupied as the brinkmanship plays out and want to take some risk out of your portfolio, please don’t hesitate to call your wealth management team to talk it through. We are loath, however, to let political uncertainty drive investment decisions.
The Fate of Backdoor Roth IRAs (and More)
This week’s reader question: What’s the upshot of the Biden administration’s tax proposals, and what should we be most concerned about going forward?
Andrew Busa, Manager of Financial Planning and Patrick Carlson, Vice President of Wealth Services had this to say:
The Biden administration maintains that any tax increases would only affect households earning $400,000 or more per year. From our read on the tax proposals released by the House Ways and Means Committee (the chief tax-writing assembly of Congress), that appears to be the case.
The legislation is aimed at two groups: High-income earners in their wealth accumulation phase and high-net-worth individuals and families in the distribution phase or who are planning their legacies with advanced estate-planning strategies. So while this does not impact everyone, the wealthy and high-income earners will end up paying more in taxes if the proposals pass.
In terms of priorities, here’s what we’re focused on as we talk through financial plans with many of you:
Anticipate income. The top marginal tax rate is expected to rise from 37% to 39.6% (the pre-Trump rate) for individuals earning more than $400,000 a year. When possible, high earners may want to pull some of next year’s income into 2021 to bypass potentially higher rates in 2022. Another option is to push last-minute charitable contributions into the beginning of 2022 (or batch this year’s contribution with next year’s, for one large contribution in 2022) to maximize the deduction.
The legislation also proposes increasing the top long-term capital gains rate from 20% to 25%. With the existing 3.8% Net Investment Income Tax layered in, that rate will actually hit 28.8% for the wealthiest Americans. If enacted—and at present it’s still a big if—this would apply to gains realized after Sept. 13, 2021. In this case, there would be some limited instances where we’d suggest avoiding taking some of the largest capital gains via tax-loss harvesting or donating stocks to charities. In most cases, however, it would not impact how we advise clients.
Decide if a Roth IRA (conversion) is right for you. The legislation proposes eliminating backdoor Roth conversions, which help high-income earners sidestep the Roth IRA income phaseout. (Additionally, Roth conversions would be prohibited altogether for taxpayers in the top income tax bracket beginning in the year 2032.)
The long and the short of it? If you are a high earner who’s considering a Roth conversion or backdoor Roth contributions, sooner would be better.
Review your estate plan. Legacy planning is also on the line for some. For instance, the current $11.7 million lifetime exclusion amount for gift, estate and generation-skipping transfer tax would sunset in 2022 (rather than the current sunset in 2026). After that, the exclusion would decrease to $6 million. And grantor trusts (IDGTs) are on the chopping block, too, and could be eliminated beginning in 2022.
In both cases, you may want to make the most of these strategies now.
As with the futility of timing the market, we have no way to predict which of these (and several other) provisions will eventually become law, but it pays to plan ahead. And we’re here to help. Stay tuned for a podcast from us on this topic in the coming weeks.
Financial Planning Focus:
Fine-Tuning Your Medicare Coverage
Medicare—federal health insurance coverage for people 65 and older—is a pivotal part of your retirement plan. With the Annual Election Period (AEP) fast approaching (it runs from Oct. 15 through Dec. 7), Medicare recipients must decide whether to make changes to their plan. But consumer beware: The devil is in the details.
Here are four key things to know about Medicare’s Annual Election Period:
1. AEP basics. This two-month window enables anyone already enrolled in Medicare to change their supplemental coverage. While the term “open enrollment” indicates that this period is “open” to anyone who’s eligible for Medicare, that’s not the case. If you’re within the seven-month window around your 65th birthday and are ready to sign up for coverage, there is a separate process called the Initial Enrollment Period.
2. Your current coverage. It is important to know a little bit about your existing benefits before considering a switch. For instance, Medicare Parts A and B—commonly referred to as “Original Medicare”—offer basic coverage that is the same for everyone. (Broadly speaking, Part A covers hospitalization and Part B covers outpatient costs.) After that, you’ll need supplemental coverage to ensure you have adequate health care throughout your retirement. You can bridge the gaps in Original Medicare by enrolling in a Part C, also called Medicare Advantage, or a “Medigap” plan, both of which are supplemental plans administered by private insurance companies. You can also opt to access Part D, the Medicare prescription drug benefit. The AEP allows you to choose these supplemental coverage options as your health needs change.
3. What you can (and can’t) change. The AEP allows you to:
Switch from Original Medicare to Medicare Advantage
Switch from Medicare Advantage to Original Medicare
Switch from one Medicare Advantage plan to another
Enroll in Part D prescription coverage or change or drop your prescription plan
If you move to Original Medicare from a Medicare Advantage plan, you will be eligible to enroll in a Medigap plan. However, be aware that you aren’t guaranteed entry into Medigap when you switch from Medicare Advantage—you may need to apply through a traditional insurance underwriting process and/or accept a higher premium based on your health status.
4. Your options. To make fully informed decisions about supplemental Medicare plans, you need to objectively assess your needs. The costs for Medicare Advantage and Part D plans often change annually, so it pays to maintain a list of your regular prescriptions to make comparison-shopping easier. If you can, project what your medical costs might look like over the next year to decide if you should switch plans.
For more on Medicare, check out our handy Medicare reference guide and our podcast on the topic.
Strategy Activity Update
Please see below for a summary of the trades we executed over the week through Thursday and our current tactical strategy allocations.
Dividend Income
No trades this week.
AIQ Tactical Global Growth
Buy SPDR S&P Transportation ETF (XTN). Sell iShares Core S&P 500 ETF (IVV).
AIQ Tactical Defensive Growth
Buy Cash Reserves. Sell iShares 20+ year Treasuries Bond ETF (TLT).
AIQ Tactical Multi-Asset Income
Buy Cash Reserves. Sell iShares JP Morgan USD Emerging Markets Bond ETF (EMB).
AIQ Tactical High Income
No trades this week.
Adviser Capital in the Media
Portfolio Manager and Vice President Charlie Toole’s dividend-stock expertise landed him in Investor’s Business Daily, where he spoke about the danger of depending on one company’s dividend.
In this week’s Market Takeaways, Research Analyst Liz Laprade explored the recent spike in bond yields, while Vice President Steve Johnson found good news amid the gloom as we enter the fourth quarter.
Looking Ahead
Expect Capitol Hill to remain in the spotlight next week. We’ll also get reads on factory orders and the service sector as well as the all-important September unemployment report.
If you’d like to learn more about our tactical or fundamental strategies, please contact Steve Johnson at 844-587-7393 or info@advisercapital.com.
Please note: This update was prepared on Friday, October 1, 2021, prior to the market’s close.
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