Can We Get That Summer Rally Back?

Please note: This update was prepared on Thursday, August 18, prior to the market’s close.

After a barnburner of a market rally during the hottest patch of the summer, investors were due for a break. And so far this week, we’ve gotten one. A tepid response from traders to some fair-to-middling earnings and economic reports has led to seesaw returns on the major stock indexes.

Cutting through the noise, here are some of the signals we’ve been watching this week and why they matter:

• The economic data out of China has been softer than expected, with the country falling far short of its growth goals as strict COVID-19 lockdowns constrain activity. While some of China’s challenges may be purely domestic—its troubled real estate sector is one drag on growth—reports of lower factory orders suggest that the slowdown in the world’s second-largest economy may be having a global impact.
• A potential upside of slower factory orders in China? More time to untangle supply chain kinks caused by backed-up ships in ports around the United States. California has been a longtime trouble spot, but landings in New York, New Jersey and Norfolk, Virginia, are also experiencing logjams as shipments have been shifted to the East Coast. The Federal Reserve Bank of New York’s tracking measure for supply chain stress showed a significant decrease in July—though it’s still well above historical levels. Any improvements, however, should help ease inflationary pressure.
• Minutes from the recent Federal Open Market Committee (FOMC) meeting showed Federal Reserve Bank policymakers weighing the eventuality of easing interest-rate hikes. For now, increases remain in the cards while officials wait to see if recent tightening is sufficient to begin to rein in inflation.
• A mixed bag of big-box retailers’ earnings reports has contributed to an up-and-down week on Wall Street, with Walmart and Home Depot both beating analysts’ projections while Target’s subpar report was blamed, in part, for a down day in the markets on Wednesday.

Chart of the Week: Inflation Rates and Stock Prices

Interim Chief Investment Officer Jeff DeMaso: 

The recent report that headline inflation fell to 8.5% in July from 9.1% in June had tongues wagging about the U.S. economy having passed through “peak inflation.”

Yet even if inflation has peaked, it is likely to remain elevated for months to come. From an investment perspective, though, what’s important isn’t the level of inflation but its direction—is it increasing or decreasing?

Starting with the S&P 500 index’s 1957 inception, we can put each calendar year into one of two piles—years of rising and years of falling inflation—based on the change in the consumer price index from January through December.

As you can see in the chart, stocks performed three times better, up 13.0% on average, in years of falling inflation versus a 4.3% average in years when inflation rose.

Of course, there are no guarantees when it comes to the stock market. It’s also possible that inflation has simply taken a breather and didn’t peak in June. But should inflation trend lower over the next year or so, and if history holds true, investors could feel a tailwind for stock market gains.

How To Steer Clear of a Tax Audit

Tax Associate Cathy Lee:

The Inflation Reduction Act, signed into law on Tuesday, contains a couple of key provisions—mentioned in last week’s update. Since then, we’ve had some questions from clients that have nothing to do with inflation reduction and everything to do with keeping more of their money out of the hands of the Internal Revenue Service.

The legislation calls for additional funding for IRS enforcement. This could result in a meaningful increase in taxpayer audits after years of decreases. The aim of this provision is to bring the number of annual audits closer to historical levels (about 1% of all filers). The IRS has pledged that this won’t affect households earning less than $400,000 per year and will instead focus on large corporate and high-net-worth taxpayers.

That’s all well and good…unless you’re a household with adjusted gross income (AGI in tax parlance) of $400,000 or more. How can you steer clear of the IRS’ crosshairs?

The best place to begin is the most obvious: Always report all your income. That’s easy when you rely on your employer’s Form W-2 or 1099 to tell the story. It gets more complex when you need to self-report small business proceeds or rental income. The IRS looks closely at income from legal partnerships and LLCs. In these cases, detailed bookkeeping goes a long way. Small business owners should always keep their personal and business bank accounts separate, save seven years of receipts (our suggestion) and keep detailed notes on all deductible expenses.

The second step is to avoid looking like an outlier. Claiming excessive investment or business losses, very large expenses or outsized deductibles can send up a red flag. If you write off that $3,000 dinner, be sure you keep the names of everyone you hosted. Yes, take advantage of deductions, but be certain you have the documentation to defend your claims.

Finally, keep an excellent record of your estimated payments and other checks you’ve written to the IRS. Payments can be wrongly recorded or coded by the IRS—always write your Social Security number on any checks you send them. And double-check your numbers. For example, if you paid $8,000 but listed $10,000 on your tax form, the IRS will spot the mismatch and turn a green eyeshade your way.

Even with the agency’s increased funding, only a small percentage of people will be audited (the audit rate for those who earned between $500,000 and $1 million in 2019 was just 0.5%, though that rate increased to 2.4% for those reporting over $5 million in income). Still, it’s better to be safe than stuck fretting about an impending tax audit.

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

Sell Cash

Buy iShares US Broker-Dealers & Securities Exchanges ETF (IAI)

AIQ Tactical Defensive Growth

Sell iShares 20+ Year Treasury Bond ETF (TLT)

Buy iShares Core S&P 500 ETF (IVV)

AIQ Tactical Multi-Asset Income

Sell Cash

Buy Real Estate Select Sector SPDR Fund (XLRE)

AIQ Tactical High Income

No trades

Adviser in the Media

Portfolio Manager Adam Johnson appeared on Fox Business to make the case for a shallow recession. It was also a busy week for Chairman Dan Wiener, who spoke to Ignites about Vanguard’s active fund outflows, new fees and new subadviser. Dan also talked to Traditional Fund Intelligence about a new Vanguard ESG fund and was quoted in Crane Data regarding their money market funds.

In this week’s Adviser Takeaways, Senior Research Analyst Liz Laprade discussed what China’s slowdown means for markets, while Diana Linn dove into Roth IRA conversions.

Looking Ahead

Next week we’ll get manufacturing and services indicators, housing market data, and consumer spending, sentiment and income reports as well the Fed’s preferred inflation gauge and consumer inflation expectations.

As always, please visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser Investments wish you a safe, sound and prosperous investment future.

About Adviser Investments

Adviser is a full-service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.