How to Handle the Market’s Volatility

Written by Rob Copeland | 20 September 2021

If it seems like the stock market has been more volatile than usual lately, it's not your imagination.

On September 9, the S&P 500 closed at 4,459, down 1.7% from the day before. Four days later it was down another .36%, before climbing by .86% the following day. Two days later, the index had dropped 1.1% from the previous level. In two weeks, the S&P fell a total of 2.25%.

It's not unusual for stocks to decline during the fall, but it's starting a little earlier this year. I expect the bumpy ride to continue, possibly for a few more quarters. There are always multiple factors in market disruptions; two of investors' current concerns are the financial troubles of the giant Chinese property company Evergrande and the fear that capital gains tax rates will rise next year.

But my longer-term concern is Covid-19 and its rampaging Delta variant. Supply chain disruptions due to Covid are making it difficult for companies to obtain components for their products. That in turn is making it harder to meet demand, which is threatening earnings. Ford Motors is a prime example of the problem: In August, sales of new Ford vehicles dropped 33% from a year earlier because of a persistent shortage of semiconductor chips. Ford isn't alone in having this issue: Chip shortages is expected to cost the global automotive industry $110 billion in revenue in 2021.

I think there's a strong possibility that companies will be unable to meet projected earnings in the next few quarters, not due to a lack of consumer demand, but an inability to fulfill orders because of supply chain issues. As a result, volatility could be with us for a while. So what does that mean for you as an investor? There are a couple of things to bear in mind.

First, the negative headwinds could affect the value of your investment portfolio. But losses are only paper losses until you sell and make them permanent. It's important that you stay patient and focus on the long-term picture: Consumer demand remains strong, supply chains will eventually get repaired, and revenues and earnings will recover. In order words, avoid panic selling, which only serves to lock in losses.

Second, be on the lookout for buying opportunities. Stocks tend to rise and fall as a whole, leaving strong businesses undervalued. The biggest gainers over the past many months could sell off hardest as investors take profits. Be on the lookout for bargains among companies that still have strong earnings prospects.

The market will likely get worse before it gets better. A 10% correction in stocks is possible. But it should be short lived: Americans are still flush with cash and eager to spend it. Supply chain snags will be cleared, revenue will be recognized in later quarters, and valuations will rebound.

The key for now is to keep a strong stomach and a cool head. Hang on to good investments unless there's a compelling reason to sell, and look for opportunities to buy future winners. Please give us a call if you'd like to discuss your investments.

Where to Invest Now? It's Tricky

Written by Rob Copeland | 13 August 2021

Where should you invest your money? Right now, that's a far from a simple question.

If you have new cash to put to work, or if you're ready to take some profits on existing investments and reallocate the proceeds, there's no obvious place to reinvest that money.

High-quality bonds are unappealing because of their low yields--10-year Treasuries are yielding just 1.3%. And the possibility of rising interest rates makes them potentially dangerous. When interest rates rise, bond prices fall. Then there's the threat of prolonged inflation, which eats into the value of bonds' interest payments. Inflation is running at a 5.4% annual rate, although it could cool down as supply chain bottlenecks related to reopening subside.

Junk bonds, issued by lower-quality companies, usually compensate for their riskiness by paying higher yields. But right now, junk bond yields are close to their pandemic lows. In other words, we're not being paid enough to take on their additional risk. That risk, of course is magnified by the potential for rising interest rates. The Federal Reserve is currently debating when to roll back its ultra-low interest rate policy.

In the past, we've successfully invested in mortgage-backed securities. But despite generating good cash flows, MBS are very expensive right now. At this time last year, MBS funds could actually be bought at a 20% discount to their intrinsic value; now they're trading at a 5% premium.

Meanwhile, stocks are expensive. Those in the S&P 500 index are trading at about 35 times their earnings, compared with their historical average of around 16. Growth stocks are even more expensive: Invesco's large-cap growth-stock ETF QQQ is trading at around 41 times earnings. It's not clear when stocks' earnings will catch up to their valuations. Until they do, stocks are at risk of being more volatile.

In other words, picking investments is unusually tricky right now. Against this backdrop, I see dividend-paying stocks as one of the best places to be. They're not especially expensive compared with the broad market (Vanguard's Dividend Appreciation Fund currently trades at 31 times earnings), so they have room to rise. Even if they don't appreciate much in the coming months, dividend stocks pay you to wait.

In looking for sectors that I consider most likely to see price appreciation, oil companies stand out, as do banks. Rising oil prices--oil has jumped from $40 a barrel last year to $64 recently--could give earning and consequently stock prices, a lift. And banks have traditionally made a lot more money when interest rates rise.

It's also important to be mindful right now of the percentage of cash within your overall portfolio. Inflation will eat away at its value, and if the market rises quickly you won't capture as much of the gains. Please don't hesitate to contact us if you'd like to talk about your investments.

Will Biden Double the Capital Gains Rate?

Written by Rob Copeland | 16 July 2021

New tax legislation is taking shape in Washington, and business owners, farmers and wealthy investors have been paying close attention to reports that the long-term capital gains tax rate could be essentially doubled.

Such a tax hike is part of President Biden's plan to raise trillions of dollars of revenue to fund multi-trillion-dollar infrastructure and social programs. The proposed capital gains increase has garnered lots of headlines and caused a fair amount of angst among those who might be affected. But I suspect there is not very much to fear.

Biden reportedly wants to raise the top individual income tax rate and the corporate tax rate, in addition to the rate paid on capital gains. He has said on multiple occasions that his increases on individuals would only affect Americans earning more than $400,000 per year.

In terms of the income tax, Biden wants to raise the top rate from 37%, where it stands now, to 39.6%. He also wants to lower the floor of the top income bracket. Under his plan, a married couple filing jointly would pay the top rate on income over $509,300; currently the threshold is $628,300.

The rate on earned income matters to investors because Biden wants to start taxing capital gains at the same. His plan calls for raising the current 20% rate on capital gains to 39.6%--but only for households with income exceeding $1 million in a given year. The 3.8% Medicare surtax on investment earnings would continue to apply, pushing the top rate to 43.4%.

Here's why I don't think this scenario will become reality. First of all, Democratic and Republican lawmakers alike have wealthy constituents and political donors, and are loathe to bite the hand that feeds. Furthermore, capital gains taxes apply to farms and family businesses as well as to investment gains—and it doesn't look good for politicians to soak farmers and family businesses.

Biden, who spent 36 years in the Senate before spending eight more as Vice President, is the definition of a savvy politician. I believe he sees the capital gains proposal as negotiating leverage, and that he will trade it away in order to secure concessions from Republicans and conservative Democrats on the scope and price tag of his infrastructure legislation. Even if the capital-gains hike does survive the legislative sausage making, it's likely that it would be significantly watered down.

Right now lots of investors are contemplating selling their appreciated stock earlier than planned in order to lock in the current 20% capital gains rate. But my advice is to avoid making major changes based on something that might not happen. As always, please don't hesitate to get in touch with us if you'd like to discuss your investments.

When Will Stocks Rise Again?

Written by Rob Copeland | 20 June 2021

Remember when the stock market seemed like it would go up forever?

Between March 20 of last year and May 7 of this year, the S&P 500 index gained 84%, driven by factors like government stimulus spending, the rise of work-from-home companies like Zoom and Amazon, and more recently, the distribution of highly effective vaccines. But since early May, the market's momentum has stalled out: After hitting a record high of 4,233, the S&P index has bounced around, mostly lower, for more than a month.

The market won't stagnate forever—over the past 20 years, its annual return has averaged 11.6%. Every substantial rise in stocks has been created by a catalyst, from falling interest rates to technological advances to stock prices declining to cheap levels. Right now most stocks, especially technology stocks, aren't cheap, and interest rates are more likely to rise than fall. So what could spark the next leg up for stock prices? I see a few possibilities:

Falling unemployment. Businesses are opening back up, but they're struggling to find workers. The Labor Department reported a record 9.3 million job openings in April, a million more than in March. And nearly 4 million people quit their jobs in April, twice as many as in the same month a year earlier.

Employers' efforts to fill jobs are being hampered by people retiring early, being unable to work because they lack childcare, being fearful to return to work because of the virus, and not needing to rush back to work because of unemployment benefits. Economists say unemployment could start to drop in the fall. And the added manpower could make companies more productive and profitable, which could drive stock prices up.

Infrastructure spending. President Biden wants to spend $2.3 trillion on infrastructure, from roads and bridges to broadband to elder care. His administration is negotiating with Republicans, who want to spend less, but one way or the other, Biden wants to sign a bill this summer. Trillions of dollars coursing through the economy would obviously drive profits and lift stocks. A combination of rising employment and infrastructure spending could create an even stronger tailwind for stocks.

A leg down. Stocks could fall significantly before rising again. Inflation, the spread of a Covid-19 variant, or any number of factors could cause a big reversal, lowering stock prices and creating good bargains for investors with cash to put to work.

I do expect stocks to remain volatile over the summer, and probably not rise significantly. But within three to six months, we could see the next catalyst or catalysts to spark the market's next leg higher. Until then, resist the urge to put cash to work if there's nothing promising to buy. Generally speaking, stocks aren't known for making significant gains during the summer months; if anything, they are more likely to fall.

There will be more good opportunities down the road, but for now, patience is a virtue. Don't hesitate to get in touch with us if you'd like to discuss your investments.