Is the Market Bottom Behind Us?

For investors following the data, the past week’s reports have been more bullish than bearish.

Positive earnings reports and upbeat economic data spurred a mini rally in tech stocks this week with the NASDAQ Composite up 2.6% on Wednesday and the other major indexes also notching gains. Readings on services (more than 70% of our economy’s engine), durable goods orders and manufacturing brought encouraging surprises this week, suggesting at least for the moment that we may not be headed for recession. We aren’t going to make a prediction either way.

Here are some of the stories that caught our eye this week and why they matter:

• The positive surprise of the week so far was the rebound in the ISM services index, which hit a three-month high (of 56.7) in July when analysts had expected further declines. Any number over 50 indicates expansion.
• Oil prices tanked and gasoline prices dropped for the 50th straight day, following a double-barreled whammy of OPEC agreeing to a modest supply increase in September and the U.S. Energy Information Administration reporting that U.S. supplies of crude oil and gas have increased.
• The jobs picture remains mixed. New claims for unemployment benefits, coming in at 260,000 this week, continued to rise but remain at below-average levels. Even though some companies put a freeze on new hires, there are still more job openings than job seekers. We’re eagerly awaiting Friday’s July jobs report.

What’s Fueling the Rally: Sentiment or Strength?

The July market rebound—during which the S&P 500 returned 9.2%—was a pleasant development after the year’s brutal start. The question now is whether the bottom is behind us or if this rally is just a bear market head fake with more pain ahead.

Market rallies—even steep ones—are not uncommon during prolonged bear markets. In the early 2000s, after the dot-com bubble burst, the NASDAQ surged more than 10% in a month nine times before finding its true bottom. And despite the recent declines in valuations, the stock market’s cyclically adjusted price-to-earnings ratio remains well above historic averages. In other words, stocks may not be as expensive as they were at the start of 2022, but they aren’t historically cheap either.

July’s rally wasn’t driven by an overwhelming amount of positive news. Arguably, all of investors’ worries were in play last month: Inflation remained high, supply chains didn’t come unkinked, the economic contraction was confirmed, war still raged in Ukraine—the list goes on. What drove stocks higher was the simple fact that things weren’t as bad as everyone feared.

Sentiment can’t carry this rally forever. We will need to see additional positive news on inflation, earnings and unemployment to conclude the worst is behind us.

Chart of the Week: The Better Recession Question

Interim Chief Investment Officer Jeff DeMaso: 

The economy—measured by real GDP—contracted in both the first and second quarters this year. So, are we in a recession or not?

We say: Who cares? The question investors should be asking is “What do we do with the information?”

To help answer this question, I identified past periods when GDP went negative in consecutive quarters and looked at how stocks (measured by the price return of the S&P 500 index) performed over the following 12 months.

Generally, stocks performed pretty darned well. The average return in the year following back-to-back quarters of economic contraction was 23.3%. That’s nearly three times stocks’ average 8.7% return in all 12-month periods.

So, if there’s one thing you should be doing if you’ve got cash, it’s buying. And if you don’t have cash, then the one thing you shouldn’t be doing is selling.

If you’re worried about the economy continuing to slide from here, look at the Great Recession. The economy contracted in the third and fourth quarters of 2008. Had you bought stocks at the end of 2008, you would’ve earned a 23.5% return over the next 12 months—despite the fact that the economy continued to contract well into 2009.

Of course, buying after a two-quarter economic decline is no guarantee. The economy contracted in 1980 and stocks declined about 7.5% in the following year. But on average, buying after a couple of negative GDP reports has been a profitable strategy.

The ‘Mega Backdoor’ Roth IRA

Manager of Financial Planning Andrew Busa:

We’re big fans of Roth IRAs. Who doesn’t love tax-free growth?

But Roth IRAs come with limitations on who can contribute to them—and how much they can contribute—based on annual income. There’s a workaround, however. One fairly common strategy that skirts these 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 without having to pay taxes on withdrawals can more than make up for today’s tax bill—especially if you expect to be in a higher tax bracket in the future.

And it gets better. A lesser-known but potentially more effective means of building up your Roth IRA assets is the “mega backdoor” Roth. It doesn’t swing open for everyone, but if it is available to you and you have the means, it may be 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 2022, individuals can contribute up to $20,500 (or $27,000 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 $61,000 (or $67,500 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 $20,500 individual contribution plus a $1,640 employer match is $22,140. Subtract that amount from the $61,000 maximum limit and Jane has up to $38,860 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 such as 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. (Legislators have considered eliminating mega backdoor conversions, but they are safe for now.) We’d be happy to help you avoid any unexpected tax hits. After all, we are The Planner You Can Talk To.

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 in the Media

Portfolio Manager Adam Johnson made the network rounds this week, appearing on the TD Ameritrade Network to highlight the good news on Wall Street and on Fox Business to give his take on calmer days for the markets.

In this week’s Adviser Takeaways, Senior Research Analyst Liz Laprade discussed whether the stock market has bottomed, while Manager of Financial Planning Andrew Busa addressed the IRS’ confusing ruling on inherited IRAs and the 10-year rule for required minimum distributions (RMDs).

And if you haven’t seen it yet, make sure to check out Chairman Dan Wiener’s candid conversation with Liz about what’s going on in the markets and the economy.

Looking Ahead

Next week we’ll get inflation reads, inventory and price updates, and a look at consumer sentiment.

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.