Bond Market Contrarianism - Adviser Investments

Bond Market Contrarianism

April 19, 2021

Please note: This update was prepared on Friday, April 16, 2021, before the market’s close.

Whether you’re talking Taylor Swift or Wall Street, records continue to be broken.

While Swift snapped a half-century-old record held by The Beatles for the fastest run of three number-one albums in the U.K., the Dow Jones Industrial Average and the S&P 500 extended their own chart-topping streaks this week. At the risk of sounding like a broken record, both indexes again reached new highs, with the Dow breaking 34000 and the S&P posting its 22nd all-time closing high of the year on Thursday.

Given the rush of good economic news, maybe the stock market’s gains shouldn’t come as a surprise. Data out this week showed U.S. retail sales trounced estimates, shooting up 10% in March, regional manufacturing rebounded to levels not seen since the ’70s, and the number of people filing for unemployment benefits fell to the lowest level since the pandemic struck.

As we’ve often said, though, the market’s biggest catalysts are earnings and interest rates—both put a wind to stocks’ backs this week. Earnings season got off to a flying start, with several major banks beating estimates.

Counterintuitively, bond prices rose and yields fell this week despite all the strong growth signals sent by the rest of the economy. We believe bond traders are finally seeing what we see—that inflation is not going to upend the economic rebound.

As of Thursday, the Bloomberg Barclays U.S. Aggregate Bond index’s yield stood at 1.49%, down from 1.54% last week, but up from 1.12% at the end of 2020. Overall, the U.S. bond market has declined 2.4% this year. On a total return basis, the Dow is up 11.8% for the year through Thursday, while the broader S&P index has gained 11.5%. The MSCI EAFE index, a measure of developed international stock markets, has returned 7.2%.

Has the Inflation Bogeyman Left the Building?  

Has the bond market taken leave of its senses? Traders have been fretting for weeks that strong economic growth would revive inflation, sending yields soaring. Yet this week, with signs of robust economic activity and consumer price inflation clocking in at 2.6% over the past year, yields fell. What gives?

As noted, we think traders are finally cottoning on to what we’ve been saying for weeks: All year-over-year numbers—whether it’s the stock market’s 56% one-year gain at the end of March  or the economic momentum we keep talking about—need to be taken with a grain of salt. When we’re comparing today’s conditions with those from last year’s lockdown lurch, most data (including inflation figures) will appear abnormally high. To put our dovishness in perspective, we think inflation will settle in at a lower level in the second half of the year as supply chain issues resolve and pandemic-influenced lows roll off the calculation.

We’re not alone. Federal Reserve Chair Jerome Powell’s messaging on “60 Minutes” this week was, yet again (talk about a broken record), that the Fed has no plans to raise interest rates until the economy returns to full employment. We think bond traders have finally accepted that yields will stay lower for longer.

The risk of a more lasting kind of inflation that proves a true hazard for investors is not one we’re cavalier about. We are constantly monitoring the markets for signs of a more permanent shift in pricing behavior. What could cause us to think inflation might become a greater factor than it is already?

One possibility is sustained upward pressure on wages as businesses rush to rehire. Reports out this week show business owners are already struggling to hire qualified workers.

Another consideration: For the first time in a generation, both fiscal and monetary policy are aligned toward encouraging growth in a big way. Even coming out of the global financial crisis in 2009, Congress quickly turned towards limiting spending. Compare that to today, where a multi-trillion-dollar infrastructure bill looks likely. If the federal government’s stimulus efforts overshoot, it could contribute to inflation.

For now, however, while those $1,400 stimulus checks certainly helped boost March retail sales, such palliative efforts are no substitute for jobs when it comes to sustained economic growth—and there are still eight million fewer people working today than there were pre-pandemic. This is why an infrastructure bill, which we expect would create jobs, stands to pave the way for current as well as future economic expansion.

SPACs’ Surge Explained

This week’s reader question is about special-purpose acquisition companies: SPACs aren’t new, so why are they so popular now, and is this a bubble?

Josh McCourt, Equity and Quantitative Research Analyst, had this to say:

That’s right, SPACs (special-purpose acquisition companies) are not fresh on the investment scene—they’ve been around since the ’90s. But they returned to center stage last year, raising billions of dollars and making a media splash with big-name institutional underwriters and celebrity sponsors.

These so-called “blank check” companies are a type of shell corporation. A SPAC has no business yet it conducts an initial public offering (IPO) to raise cash, and then looks for a private company to acquire. If the SPAC doesn’t find a company to buy within a set timeframe, investors get their money back. If it completes a buy, then the private company becomes a public company, and shareholders of the SPAC now own the new entity—which takes the money in the SPAC and (hopefully) uses it to fund growth.

Why are SPACs so popular right now? Some of the surge can be explained by market conditions. Pandemic-fueled volatility made it more difficult for companies to go public via a traditional IPO. Going public through a SPAC vastly simplifies the process, with quicker closings, lower costs and fewer regulatory requirements compared to a traditional IPO.

On top of that, there’s a FOMO (fear of missing out) aspect in play. Headlines touting splashy SPACs—including online betting company DraftKings and payment firm Paya—have raised their profiles and made SPACs seem like a compelling investment for retail investors who have little to no access to the IPO market.

Some of the SPACs out there may turn out to be decent investments, but we consider the current market for them to be a bubble.

What’s more, SPACs are highly speculative—you are trusting the sponsor to make one good (ideally great) investment bet when it merges with a private company. SPACs themselves tend to trade around their (almost always) $10 listing price until a merger has been confirmed. After that, the sponsors exit and prices often fall below $10, leaving investors holding the bag. Despite the trend, SPACs have already raised more money in 2021 than they did in all of 2020.

They’re also raising eyebrows at the Securities and Exchange Commission, Wall Street’s federal watchdog, which warned that some companies may need to restate their financial results due to questionable accounting practices. SPACs have come under increased scrutiny from lawmakers as well.

Speculation aside, any investment entails understanding what you own, how it’s valued and who is steering the ship—with a SPAC, virtually all of those questions remain unanswered until it’s too late. Caveat emptor!

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Financial Planning Focus:

Switch ZIP Codes, Claim Tax Advantages

Each of our 50 United States are wonderful in their own, unique ways, but some offer greater financial benefits to their residents than others. Whether you’re thinking about working remotely, moving closer to your kids or grandkids, or simply getting away from winter gloom, don’t forget that there are tax advantages to claim if you move to a lower-tax state.

Here are five things to keep in mind to reap the benefits of a new ZIP code:

  1. Establish Domicile. From a tax perspective, domicile and residence are two separate concepts. You can own multiple residences, but you can only have one domicile—and it’s your domicile that determines where you owe taxes. Simply owning property in a state is not enough. While states’ laws on establishing domicile vary, there are two rules that generally apply. First, your domicile must be your principal and permanent place of residence. Second, you must intend to return to and remain in that residence for an indefinite period of time.
  2. Show Intent. How do you prove to Uncle Sam that you intend to stick around in your new home? Here are some convincing specifics:
    • You’re registered to vote there
    • You have a network of local professionals (doctors, dentists, accountants, etc.)
    • Your driver’s license and vehicles are registered there
    • Your family heirlooms and other valuables are kept there
    • You’ve joined local social organizations
    • You have a gym membership

3. Track Time Spent. You have to spend over half of the year (183 days) at your new home for it to qualify as your principal place of residence. Keep track of receipts, travel charges, flight and cell phone records, etc. to prove you were living in your desired domicile for the majority of the year in case your tax filing triggers a residency audit.

4. Sever Ties to Your Previous Domicile. To strengthen your case, it’s wise to minimize ties with your old home. The easiest way to do that is to sell any real estate you own there. Or, if you plan to hold onto multiple homes, try to keep a low profile there for at least a few years. The tips listed above also work in reverse: Cancel your old gym memberships, close bank accounts, sever affiliations to clubs or organizations to help make the case that you are no longer a permanent resident.

5. File Appropriately and Update Your Financial Plan. Once you’ve established your new domicile, make sure to file your federal income tax return using your new address. Depending on the state, you may also need to file a Declaration of Domicile document. And remember to keep your network of financial professionals in the loop. In particular, work with your attorney or adviser to update your estate plan to reflect new state laws.

As you can see from the above, establishing domicile in a new state isn’t easy. The IRS wants to be sure you have every intention of making this your new home. If you have any questions about your situation, please reach out to us. We are happy to help. After all, we are The Planner You Can Talk To.

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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

Sold iShares Core S&P Small-Cap ETF (IJR). Bought iShares Core S&P 500 ETF (IVV).

AIQ Tactical Defensive Growth

No trades this week.

AIQ Tactical Multi-Asset Income

Bought iShares iBoxx USD High Yield Corporate Bond ETF (HYG) using cash.

AIQ Tactical High Income

No trades this week.

Adviser Investments’ Market Takeaways

You can find a new Market Takeaways video on our website. Vice President Steve Johnson discussed the surprising New England weather along with the counterintuitive moves in the bond market this week.

Looking Ahead

Next week is a busy one. We’ll get reports on durable and capital goods orders, home prices and homeownership rates, and a bevy of reads on consumers, with data on personal income, spending, savings and sentiment. Earnings season will continue apace, and the Federal Reserve’s open market committee will host two days of meetings.

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, April 16, 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.

Purchases and sales of securities listed above represent all securities bought and sold in each strategy during the period stated. Each strategy’s portfolio generally includes more holdings in addition to the transactions listed above and in some cases the securities listed above may only represent a small portion of the particular strategy’s complete portfolio. Further, the securities listed above are not selected for listing based on their investment performance; thus it should not be assumed that any of the securities listed above were profitable or will be profitable, nor should it be assumed that future recommendations will be profitable. Clients and prospective clients should only make judgements about a strategy’s performance after reviewing the strategy’s composite performance information. There is no assurance that each security listed above will remain in the strategy’s portfolio by the time you have received or read this email. Securities are listed for informational purposes and are not intended as recommendations. Existing investor accounts may not participate in all transactions listed above due to each account’s particular circumstances.

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