Are We Headed for a Soft Landing?

iPhones, ISMs and Oil Prices—Michelle Knight, President and Chief Economist of Ropes Wealth Advisors

Please note, this article was originally published by Ropes Wealth Advisors (RWA), a subsidiary of Adviser Investments, before the markets closed on Friday, September 8, 2023. Click here for more on the partnership between our two firms and here to read more about Michelle. 

You know you are the parent of a teenager when you read the headlines about China banning iPhone use for state-owned corporations, and your first thought is, I wish I could wield that kind of power.

But seriously, it was big news for the market this week that Apple, one of the market’s darlings, could experience such a blow. Shares dropped accordingly, losing close to 7% over two trading sessions, which brought the broader market down with it.

The iPhone ban was not the only news out of China that caused markets some angst this week. The latest Caixin services PMI (purchasing managers index) dropped to its lowest this year, falling from 54.1 to 51.8 in August, barely in expansion territory.

Against expectations, retail sales have also been tepid, and youth unemployment in China rose to 21.3% in June, a record high. Chinese exports have dropped 14.5% over the past 12 months, the weakest pace since February 2020, and imports contracted 12.4%. A faltering Chinese economy will have an outsized impact on companies in certain U.S. and European stock sectors with heavier exposure to business there, including tech, materials and industrials.

Closer to home, the U.S. services sector unexpectedly gained steam in August, with new orders firming and businesses paying higher prices for inputs—potential signs of still-elevated inflation pressures. The Institute for Supply Management’s non-manufacturing PMI rose to 54.5 last month, the highest reading since February and up from 52.7 in July. (A reading above 50 indicates growth in the services industry, which accounts for more than two-thirds of the economy.) While this report demonstrated the good news of U.S. economic resilience, the market instead focused on what it might mean for the Federal Reserve, which next meets September 19–20 and may feel pressured to raise interest rates.

This week’s initial jobless claims fell to 216,000, the lowest weekly reading since late January, which clashed with last week’s payrolls data that suggested the job market has continued to loosen. Additional government data showed unit labor costs rose and productivity fell in Q2. It looks like instead of laying off people, companies are cutting hours, but that still is not helping alleviate the issue of higher and stickier labor costs.

Speaking of the Fed, this week saw the release of its Beige Book survey of conditions across the 12 central bank districts. The results were mixed. Overall, most Fed districts indicated economic growth was “modest” in July and August, according to the report. “Consumer spending on tourism was stronger than expected,” perhaps reflecting the last stage of pent-up demand for leisure travel from the pandemic era. “But other retail spending continued to slow, especially on non-essential items,” the report adds. “Some districts highlighted reports suggesting consumers may have exhausted their savings and are relying more on borrowing to support spending.”

Assessing the labor markets, Fed officials say job growth was “subdued” across the nation. Still, though hiring slowed, “most districts indicated imbalances persisted in the labor market as the availability of skilled workers and the number of applicants remained constrained.”

A final blow to sentiment to start September was caused by reports that Saudi Arabia and Russia will extend a voluntary oil production cut. WTI crude prices rose to close to $88 per barrel as a result. Following the announcement, U.S. National Security Advisor Jake Sullivan said that President Biden is “doing everything within his toolkit to be able to get lower prices for consumers at the gas pump.” Higher fuel costs are the last thing Americans need right now.

With all that, investors may be reconsidering some of their year-to-date market enthusiasm as they focus on the combination of a slowing economy and still-high inflation. Reflecting on hawkish recent Fed speak, investors are scaling back hopes the Fed may be prepared to ease policy and lower interest rates early next year. We have long been wary of that presumption and reiterate our advice to stay balanced and flexible, but not afraid. Higher debt costs for consumers, businesses and governments will mean slower growth in the near term. But as we look forward, and as better fiscal management is implemented to deal with those higher debt costs, there is all the potential in the world for higher growth in the future built on a much more quality base. We just have to get from here to there.

Which Path Will the Economy Take?

We stand at a crossroads. At any given time, a wide range of ever-shifting factors determines which direction the economy will move overall. But how can an investor set expectations for those potential outcomes?

This week, our investment team has tackled that challenge. They’ve outlined the three most likely paths for the economy and the repercussions for inflation, bond prices, unemployment, Federal Reserve policy and overall GDP.

So, which path are we on? Based on strength in the job market, Fed commentary, company earnings and continued economic resilience, among other indicators, we believe a soft landing is the most likely outcome. We’ll keep you posted on developments of note and how they might impact your wealth plan. 

Contribute too Much to Your IRA? Here’s What To Do

You’ve probably heard it before: If you can, maximize contributions to your individual retirement account (IRA) every year. But what happens if you make an excess contribution to your IRA?

It’s easier than you might think.

The contribution limit for IRAs in tax-year 2023 is $6,500. If you’re 50 or older, you can also make a $1,000 catch-up contribution, raising that total to $7,500.

Here’s where it gets tricky. As your income rises, you enter the phase-out range for contributions. This means that you lose the ability to deduct contributions to a traditional IRA on your tax return. Or if you’re contributing to a Roth IRA, it means your personal maximum contribution goes down as your income rises above certain thresholds (see page 2 of our Key Financial & Tax Planning Data desk reference).

This phase-out range is what can get people in trouble—if you’re married, file a joint tax return and have an employer-sponsored retirement savings plan, you are unable to take the full tax deduction on your contributions to a traditional IRA starting at a combined adjusted gross income of $116,000. So if you make more than that and make a $6,500 contribution, the IRS will want some payback when you file your taxes.

What then?

Worst case, you’ll be on the hook for a 6% penalty on those excess contributions each year when you file your taxes. The good news: If you act fast enough, you can reduce or even eliminate the penalty.

If you notice that you’ve overcontributed to your Roth or traditional IRA, you have until the tax deadline (extension included) to correct it—but the sooner you correct it, the better.

The IRS has a formula (which we will spare you) that requires you to compare the value of the IRA before the excess contribution to its current value. With this information, you can calculate the net income attributable (NIA)—the amount that you earned on your excess contribution. The NIA plus the excess contribution is what you’ll have to withdraw to escape the penalty.

Here’s an example:

Sarah realized that she made an excess contribution of $1,500 to her IRA for 2023. She has an adjusted opening balance of $8,000 and an adjusted closing balance of $8,500. Her NIA would be $93.75. She would have to remove a total of $1,593.75 ($1,500 + $93.75) from her IRA and pay income taxes on the $93.75 earned. If she’d failed to make this correction before the tax deadline, she’d have to pay a 6% tax on the excess contribution every year until she withdraws the $1,500 and the NIA (which will likely grow to a larger and larger sum over time).

If you think you’ve made an excess contribution to your IRA, please contact your advisor immediately. They will work to help you reduce penalties and tax headaches.

Adviser Market Update

• Inflation ticked up in August, with the consumer price index rising 0.6% from the prior month and 3.7% year-over-year. The main culprits were gas and food prices, which have gone up over the summer. Core inflation, which does not include food and energy, rose a more modest 0.3% last month.
• The Federal Reserve is set to meet next week. Even with inflation trending up, our expectation is that the central bank will not increase interest rates. The CME’s FedWatch tool puts the probability of no hike at 97% as of this morning.
• Small business owners cited sticky inflation as one reason they are less confident the economy will improve over the next six months as of August. That said, the National Federation of Independent Businesses reported that 17% of respondents are planning to create new jobs in the next three months, which is at odds with the overall pessimism.