Inflation Ups Pressure on Fed to Make Historic Hike

Inflation Ups Pressure on Fed To Make Historic Hike

July 14, 2022

Please note: Beginning today, Adviser’s Week in Review will arrive in your inbox on Thursday afternoons instead of Fridays! We’ve made the change so that you can have our updates and insights a day earlier each week.

Here are the themes that matter this week:

  • Inflation hit 9.1% in June, exceeding estimates. It heightened already elevated recession fears on Wall Street, leaving investors and analysts wondering whether the Federal Reserve might raise interest rates by as much as 1% later this month. That would represent the largest increase to the fed funds rate since May 1981, when the Fed made a pair of successive 2% hikes to aggressively combat runaway inflation.
  • The dollar’s rally continued—the greenback attained parity with the euro for the first time in two decades intraday on Wednesday. It may be a good time to book a trip to Europe—if you can find an affordable flight, given that…
  • Delta Airlines, the first carrier to report second-quarter earnings, undershot profit expectations even as traveler demand returns to pre-pandemic levels. The cause? Increased labor and fuel costs. Jamie Dimon, CEO of JPMorgan Chase, provided a cautious outlook on his company’s earnings call Thursday morning, citing concerns about inflation and a weakening economy. With a flood of earnings data on the way, we’ll be looking closely at results as well as what corporate leaders say they expect for the rest of the year (see the Chart of the Week below for more).
  • Two-year Treasurys are yielding almost a quarter percent more than 10-year Treasurys this week. This phenomenon, known as a yield-curve inversion, is the widest it has been in 20 years and some analysts consider it a precursor for recession. We believe the 10-year to three-month Treasury spread (which is not currently inverted) may be a stronger recessionary signal.
  • Global shipping costs appear to be coming back to Earth, thanks to faster transit times and easing port congestion, lessening one source of inflationary pressure.

We’ll have much more to say in our upcoming quarterly Adviser Outlook, which will be mailed out and land in your email inbox (if you’ve opted for electronic delivery) next week. For now, remember that we’re here anytime you want to talk about the current economic or market environment and its impact on your long-term financial plan.

Is High Inflation Running Out of Gas?

Prices rose 9.1% in June compared to a year prior, according to this week’s consumer price index (CPI) reading. That’s a four-decade high, fueled by gas prices rising in June (up 11.2% from May) as summer travel season kicked into gear amid energy shortages touched off by Russia’s invasion of Ukraine and a dearth of domestic refineries.

Is there relief in sight? Possibly. Through Wednesday, gas prices had declined for 28 straight days. And while painful on the pocketbook, filling up isn’t necessarily the burden we’ve come to believe; personal fuel expenditures currently account for 3.5% of total consumer spending, which is below the 3.6% monthly average over the past 30 years.

Then there’s the Federal Reserve—spurred by doggedly high inflation to possibly go big again with a larger-than-expected rate hike at the conclusion of its upcoming July 26–27 meeting. Traders are beginning to price in a more aggressive anti-inflation tack—a full percentage point hike.

It’s realistic to expect central bankers to act decisively to try to slow price increases. The concern with big policy moves is that they will overcorrect the economic pendulum and cause a recession. But with unemployment near all-time lows and with the impact of inflation hitting consumers and businesses harder, Fed watchers anticipate the policymakers will accept an economic slowdown to achieve price stability.

What might this mean for Wall Street and Main Street? In short, better yields on savings accounts and bonds, higher costs to borrow and, hopefully, lower prices for goods and services as the effect of rate hikes ripples out through the economy. But it could also come with higher unemployment, a reduction in wages and slowdowns in industrial production. It’s far too soon to tell. A middle ground (and the desired result) would be a “soft landing” where inflation is brought under control without sending the economy into recession.

Chart of the Week: The Earnings Expectations vs. Reality Gap

Charlie Toole Portfolio Manager Charlie Toole:

Wall Street analysts expect companies in the S&P 500 to report profits 4% higher than one year ago. If what’s past is prologue, we can expect two things: (1) That estimate is wrong and (2) it’s possibly too low.

Over the last four years, Wall Street analysts have made meteorologists look like soothsayers. On average, their predictions for earnings growth when companies start to report quarterly profits have missed the mark by about 9%. As baseball player Yogi Berra famously quipped, “It’s tough to make predictions, especially about the future.”

In addition to missing the mark, analysts have been too conservative. In 14 of the last 15 quarters, analysts’ estimates came in under companies’ actual results.

If the Street has set another low bar this quarter, then earnings growth that hurdles the consensus 4% estimate would be some much-needed positive news in a market that’s been dominated by negative headlines.

This chart shows analysts' expected earnings for S&P 500 companies vs. the actual reported results each quarter from 2018 through June 2022. Note: Chart shows analysts’ expected year-over-year earnings growth for S&P 500 companies (as of the prior quarter-end) alongside actual reported earnings results from 9/30/2018 through 6/30/2022. Source: FactSet.

Advanced Estate Planning: Passing Money to Heirs

Passing on wealth to family members and heirs is one of the primary objectives of many of the financial plans we create for clients. And thanks to today’s tax code, there’s never been a more favorable time to do so.

At present, you can give up to $16,000 each year ($32,000 if you’re married) to as many people as you’d like during your life. Upon death, you can leave up to $12.06 million ($24.12 million for married couples) in cash, securities or other assets to heirs without incurring any federal estate or gift tax. However, these particular tax exemptions are set to expire at the end of 2025 and could change even sooner as part of a budget deal or infrastructure package passed by Congress.

How else can you maximize the amount your loved ones receive while taking taxes into account? Here are four ways trusts can help.

  1. Roth IRA conversions. The SECURE Act eliminated the “stretch IRA” provision that allowed non-spouse IRA beneficiaries and trusts to stretch required minimum distributions (RMDs) out over the life of an heir. Now those assets must be distributed to beneficiaries at ordinary income rates within 10 years of the original owner’s death. And when trusts are the beneficiaries, the tax rate is even higher than that of ordinary income. One simple solution: Keep the trust as beneficiary but convert the IRA to a Roth—thus making future distributions tax-free.
  2. Irrevocable life insurance trusts. An irrevocable life insurance trust (ILIT) is another tax-efficient way to pass significant assets down to your heirs. The ILIT owns a life insurance policy on the grantor’s life. When the grantor passes, the proceeds fund the trust and are distributed to beneficiaries according to the ILIT’s terms. Life insurance proceeds not held in an ILIT are taxed as part of the insured’s estate. With an ILIT, those proceeds are excluded from the insured’s estate, reducing the estate tax burden.
  3. Intentional grantor trusts. These irrevocable trusts are funded with your assets during your lifetime. Normally such a trust would employ estate, gift and generation-skipping tax (GST) exemptions but still owe income taxes on the growth of the assets. However, if structured properly, an intentional grantor trust can maintain the gift and GST exclusion while enabling the grantor to pay income taxes on the growth of the assets while they are living. This allows the trust to grow without triggering high taxes when you pass, leaving a larger pool of assets for your heirs.
  4. Grantor retained annuity trusts. Interest rates (although on the rise) remain historically low. This makes grantor retained annuity trusts (GRATs) worth a look. Basically, GRATs are funded by the grantor in exchange for a stream of annuity payments, including the original deposit, over a specified period and at a predetermined interest rate. After the final annuity payment occurs, whatever remains in the trust is transferred to the beneficiary. If interest rates remain relatively low, many asset types and classes should appreciate faster than the distribution rate. That growth is then passed on to the trust’s beneficiaries free from gift and estate taxes. However, there’s a catch: If the grantor dies before the term of the trust ends, the beneficiary gets nothing and the trust is included in their estate.

These estate-planning strategies provide some smart options, but they can be complex and expensive to set up. Talk to us before pursuing any of these options. We are happy to help!

Podcast: Employee Stock Purchase Plans—When, Why and How To Use Them

Stock options can be a great wealth-building tool—but only if they’re used right. In this third episode in our trilogy, Manager of Financial Planning Andrew Busa and Financial Planner Michael Dillaire tackle the intricacies of maximizing your options and discuss employee stock purchase plans (ESPPs). Topics include:

  • When and how much you can purchase through an ESPP
  • How lookback periods can be used to maximize your options
  • The tax benefits of using an ESPP
  • What portion of your portfolio it’s wise to tie up in an ESPP

Working out just how much you can benefit from employee stock options isn’t easy. But it’s worthwhile. Our experts can help you navigate this tricky process. Listen now to learn more.

Or check out our other episodes on stock option basics and restricted stocks. Thanks for tuning in!

Jim Lowell and Jeff DeMaso Are Moving Up

After 23 years as Adviser Investments’ chief investment officer, Jim Lowell is moving into a specially created post as strategic adviser to the CEO, Mario Ramos. Jim remains an active member of Adviser Investments’ board of directors, and his new role will enable him to focus on adding services that help us meet our clients’ growing range of needs.

Jeff DeMaso, a name regular readers know well, becomes interim CIO. As director of research here at Adviser Investments for over a decade and a member of the Senior Investment Committee, the work of a CIO is nothing new for Jeff. He was named a “rising star” by Citywire in 2019 and was recently appointed portfolio manager for our core strategies. With Chairman Dan Wiener, he is also co-editor of The Independent Adviser for Vanguard Investors newsletter.

Congratulations to both Jim and Jeff! Their respective talents and tenure add enormously to our enduring culture of client service here at Adviser.

Ask Us a Question!

We’re always interested in the topics or concerns you might like us to comment on. As much as we try to cover the investment and economic fields every week, we know there’s still more that you might want to hear about. Ask us a question about investing, the markets or financial planning and one of Adviser Investments’ experts will answer it in a future edition of The Week in Review. CLICK HERE NOW TO POSE YOUR QUERY.

Adviser’s Today’s Market Takeaway

In this week’s Today’s Market Takeaway, Senior Research Analyst Liz Laprade discussed the latest twist in Elon Musk’s Twitter saga.

Looking Ahead

Next week brings a bevy of fresh reads on the increasingly fraught housing market, including homebuilder sentiment, building permits, housing starts and existing home sales. We’ll also get helpful looks at manufacturing, the service sector and leading economic indicators while second-quarter earnings reports continue to flow in.

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 Investments is a full-service wealth management firm, offering investment managementfinancial and tax planningmanaged 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.


Please note: This update was prepared on Thursday, July 14, 2022, prior to the market’s close.

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