Please note: This update was prepared on Friday, August 13, 2021, before the market’s close.
Medical and economic booster shots made headlines over the past week as stocks continued to climb higher.
The Food and Drug Administration (FDA) authorized an extra vaccine dose for immunocompromised individuals on Thursday, shielding some of the most vulnerable Americans from the highly contagious delta variant of COVID-19.
Meanwhile, stocks got a jab of their own from a cocktail of positive data: Robust quarterly earnings, an improving job market and actual progress on the biggest infrastructure package in more than a decade.
Even with delta rainclouds hovering over the market’s summer cookout, the S&P 500 index notched its 47th record close of 2021 on Thursday, while the Dow Jones Industrial Average hit a new high-water mark of its own. And the summer cheer extended across the pond. The STOXX 600, an index of European stocks, posted its 10th consecutive all-time best on Friday—the longest streak in more than two decades.
All those records have translated into some very attractive returns for stocks. On a total return basis, the Dow is up 17.3% for the year through Thursday, while the broader S&P 500 has gained 19.8%. The MSCI EAFE index, a measure of developed international stock markets, has returned 11.7% through Thursday. The Bloomberg Barclays U.S. Aggregate Bond index’s yield stood at 1.47%, up from 1.12% at the end of 2020. Overall, the U.S. bond market has declined 1.2% year-to-date.
Inflation: Hot, But Cooling
Has the “transitory” nature of the current inflationary spike been confirmed? Not yet, but there were some encouraging signs in July’s Consumer Price Index (CPI) report released this week. While overall prices paid by consumers rose 5.4% in July from the same time last year (when much of the economy was in lockdown), they rose just 0.5% on a seasonally adjusted basis from June—the smallest monthly increase since February.
Much of the inflation we see today is related to reopening surges and supply chain bottlenecks for consumer goods and services. As we’ve noted, we believe these bottlenecks will get sorted out, easing the pressure on prices.
At the same time, we are keeping a close eye on one area where already high prices may yield to even higher prices—housing.
An important component of most broad inflation measures is a gauge called owners’ equivalent rent (OER)—the money a property owner would have to pay in rent to equal their total costs of homeownership. At just under 25%, the OER is the largest component of the headline CPI.
In July, OER rose 2.4% from the same time last year—still well below the 3.2% it averaged in the five years before the pandemic. That sounds benign, so why are we raising a cautionary flag here?
Though OER has been low, home prices have been rising by double digits year-over-year. And while you’d think OER would track with the cost of homes, it typically lags them. By one measure, the OER trails the S&P CoreLogic Case-Shiller Home Price index (a benchmark for U.S. residential real estate values) by 15 months.
So, it’s possible that as supply chains reconnect, driving inflation lower, any improvements on that front may be offset if OER continues to rise.
Real-Time Economic Growth
Since the beginning of the pandemic, we’ve monitored high-frequency data sets to get a sense of consumer behavior in real time. Unlike with most official economic reports, which are released weeks or months after the fact, we can see evidence of people eating out or traveling on a daily or weekly basis. And the numbers suggest we may be in the early stages of an economic slowdown.
According to the reservation app OpenTable, people began returning to restaurants at pre-COVID levels after Memorial Day, but they’ve started eating at home again in the last month or so. Fewer in-person meals means lower profits for restaurants, reduced hiring and salaries, and of course, fewer tips for those who are working.
We can also get a real-time glimpse at travel through the Federal Highway Administration’s truck and automobile mileage data. Truck traffic is slightly above 2019 levels—a positive growth indicator given the headwinds of high gas prices and stubborn supply chain constraints—but car travel has yet to return to pre-pandemic levels and has recently been trending down. The same can be said about air travel.
We’ve consistently asserted that the pace of second-quarter economic growth was not going to be sustainable. And the near-real-time data confirms that economic activity is slowing. Is it the delta variant hitting the brakes on economic growth or is it something else? It’s unclear for now, but we don’t feel that another recession is in the cards. Remember, a slowing economy can still be a growing economy.
One-Year Gains Aren’t Sustainable
As potent as this pandemic bull market has been, one-year returns are falling steadily: In mid-March this year, the S&P 500’s return over the prior 12 months was almost 78%; by the end of March, it was 56%. At June’s end, the one-year figure was 41%. Yesterday, that mark was about 34%. You get the picture.
This might seem counterintuitive during a period when the S&P 500 is hitting record highs with regularity—but the declines in one-year returns don’t mean the market isn’t gaining ground. It simply reflects the fact that gains being achieved today are smaller than those earned a year ago as the market roared back from its early-pandemic turmoil.
Perspective is warranted. A 78% annual return from stocks is unsustainable, as is a 34% return! That doesn’t mean investors can’t continue to compound their money at a decent clip in the stock market. We’re just saying that you shouldn’t take the recent level of returns and project them forward year after year.
Podcast: Have Earnings Peaked?
Is this as good as it gets for corporate earnings growth? Nearly every company represented in the S&P 500 index has exceeded analysts’ earnings expectations again this quarter, with the average company bringing 17% more to the bottom line than forecasted.
Are these brilliant numbers just a paper façade or do they indicate real strength in the economy? In this week’s podcast, Portfolio Managers Steve Johnson and Charlie Toole discuss:
How much of the earnings boom is due to the “base effect”
The surprising resurgence of large-cap tech stocks
Whether record-high profit margins are sustainable
The sectors that are still suffering from the pandemic’s effect
As we noted earlier, the stock market has climbed to some dizzying heights over the past year and continues to advance on strong earnings. Will the delta variant trip it up? Click here to listen now!
Financial Planning Focus
The ‘Mega Backdoor’ Roth IRA
At Adviser Investments, we’re big fans of Roth IRAs. Who doesn’t love tax-free growth?
Roth IRAs come with limitations on who can contribute—and how much they can contribute—based on annual income. However, one fairly common strategy to get around those limitations is the “backdoor” Roth conversion—you roll (or transfer) funds from a traditional 401(k) or IRA into a Roth IRA.
Yes, you’ll pay taxes on the amount converted, but if your retirement is many years down the road, the potential to compound tax-free for years and years can more than make up for today’s tax bill—especially if you expect to be in a higher tax bracket in the future.
A lesser known, but potentially more effective, means of building up your Roth IRA assets is the “mega backdoor” Roth. This backdoor doesn’t swing open for everyone, but if it is available to you and you have the means, it’s worth walking through.
Here’s how it works:
A mega backdoor Roth conversion allows you to roll over post-tax funds from a traditional 401(k) into a Roth IRA. Normally, contributions to a 401(k) are pre-tax; however, once you surpass the individual contribution limit, some employers have plans that allow additional after-tax contributions.
In 2021, individuals can contribute up to $19,500 (or $26,000 if you are 50-plus years old) to a 401(k). But if your employer allows after-tax contributions to your 401(k), you can up your contribution to $58,000 (or $64,500 if you are 50-plus years old), then roll that excess into a Roth.
Let’s look at a specific example:
Jane is under age 50. She maxes out her 401(k) contribution and has an employer match of 8%. Her $19,500 individual contribution plus a $1,560 employer match is $21,060. Subtract that amount from the $58,000 maximum limit, and Jane has up to $36,940 that could be added to her 401(k) and rolled into a Roth IRA with the mega backdoor option. Talk about a double dose of retirement savings!
Here’s when a mega backdoor Roth IRA may be right for you:
Your company allows both after-tax contributions and in-service withdrawals to a Roth IRA
You’ve already maxed out your 401(k) and IRA contributions
You have excess savings after monthly expenses, including an emergency fund, higher education costs and other debt obligations. (Use our Budget Worksheet to get started on determining your expenses, income and potential additional savings.)
The tax implications can be tricky to navigate, so if a mega backdoor Roth sounds like something you or a loved one might be able to use, give us a call. We’d be happy to help you avoid any unexpected tax hits. After all, we are The Planner You Can Talk To.
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.
No trades this week.
AIQ Tactical Global Growth
Sell Fidelity MSCI Real Estate index (FREL). Buy iShares US Broker-Dealers & Securities Exchanges ETF (IAI).
AIQ Tactical Defensive Growth
Sell iShares 20+ Year Treasury Bond (TLT). Buy iShares Core S&P 500 ETF (IVV).
AIQ Tactical Multi-Asset Income
Sell Invesco DB Commodity Index Tracking Fund (DBC). Buy Invesco DB Agriculture Fund (DBA).
Next week, we’ll get a look at the minutes from last month’s Federal Reserve meeting—we’ll be reading their taper talk closely. We’ll also see housing-related data (homebuilders’ confidence, housing starts, building permits), manufacturing reads, leading economic indicators and retail sales data.
As always, you can 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.
Please note: This update was prepared on Friday, August 13, 2021, before the market’s close.
This material is distributed for informational purposes only. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.
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