Estate Planning Primer
Author: Minich MacGregor Wealth Management
The Springs of Inspiration
Every Memorial Day, we as Americans take time to remember the soldiers who died serving our country. We lay flowers at their graves. We touch the monuments erected in their memory. Sometimes, we even walk on the same battlefields where they fought and fell. Knowing all the while that we wouldn’t be here without them.
In our opinion, this is an American tradition as patriotic as singing the national anthem or reciting the Pledge of Allegiance. And it makes Memorial Day as important as Independence Day or Thanksgiving. Saluting our fallen, honoring their sacrifice, and vowing to build on the ground they broke is the least we can do. Furthermore, we believe it inspires us all to be greater citizens ourselves.
Recently, we came across a speech given by President Woodrow Wilson on May 30, 1914, at the National Cemetery in Arlington. At the time, Memorial Day already had a long history, but it was not yet as standardized as it is today. But with the last veterans of the Civil War passing away, and new storm clouds gathering over Europe – World War I would break out a few months later – more and more Americans were realizing the importance of giving thanks to those who gave their lives.
Wilson’s speech – which he apparently gave without any preparation – perfectly describes why this is such a vital tradition. In honor of the holiday, we thought we would share some excerpts from it with you. We hope the words touch your heart as much as they have ours.
We are so grateful for this nation. We are so humbled by the knowledge others died so that our country might live. Now, it is our job to ensure their memories forever live on, too.
On behalf of everyone here at Minich MacGregor Wealth Management, we wish you a safe and peaceful Memorial Day.
Memorial Day Address
Given by Woodrow Wilson, 28th President of the United States, on May 30, 1914
Ladies and Gentlemen, I have not come here today with a prepared address. But I will not deny myself the privilege of joining with you in an expression of gratitude and admiration for the men who perished for the sake of the Union. They do not need our praise. They do not need that our admiration should sustain them. There is no immortality that is safer than theirs. We come not for their sakes but for our own, in order that we may drink at the same springs of inspiration from which they themselves drank.
Whenever a man who is still trying to devote himself to the service of the Nation comes into a presence like this, or into a place like this, his spirit must be peculiarly moved. A mandate is laid upon him which seems to speak from the very graves themselves. Those who serve this Nation, whether in peace or in war, should serve it without thought of themselves. I can never speak in praise of war, ladies and gentlemen; you would not desire me to do so. But there is this peculiar distinction belonging to the soldier, that he goes into an enterprise out of which he himself cannot get anything at all. He is giving everything that he hath, even his life, in order that others may live, not in order that he himself may obtain gain and prosperity. And just so soon as the tasks of peace are performed in the same spirit of self-sacrifice and devotion, peace societies will not be necessary. The very organization and spirit of society will be a guaranty of peace. Therefore, this peculiar thing comes about; that we can stand here and praise the memory of these soldiers in the interest of peace. They set us the example of self-sacrifice, which if followed in peace will make it unnecessary that men should follow war anymore.
We are reputed to be somewhat careless in the use of the English language, and yet it is interesting to note that there are some words about which we are very careful. We bestow the adjective “great” somewhat indiscriminately. A man who has made conquest of his fellow-men for his own gain may display such genius in war, such uncommon qualities of organization and leadership that we may call him “great,” but there is a word which we reserve for men of another kind and about which we are very careful. That is the word “noble.” We never call a man “noble” who serves only himself; and if you will look about through all the nations of the world upon the statues that men have erected, you will find that almost without exception they have erected the statue to those who had a splendid surplus of energy and devotion to spend upon their fellow-men. Nobility exists in America without patent. We have no House of Lords, but we have a house of fame to which we elevate those who, forgetful of themselves, study and serve the public interest, who have the courage to face any number and any kind of adversary, to speak what in their hearts they believe to be the truth.
We admire physical courage, but we admire above all things else moral courage. I believe that soldiers will bear me out in saying that both come in time of battle. I take it that the moral courage comes in going into the battle, and the physical courage in staying in. There are battles which are just as hard to go into and just as hard to stay in as the battles of arms, and if the man will but stay and think never of himself there will come a time of grateful recollection when men will speak of him not only with admiration but with that which goes deeper – with affection and with reverence.
So that this flag calls upon us daily for service, and the more quiet and self-denying the service, the greater the glory of the flag. We are dedicated to freedom, and that freedom means the freedom of the human spirit. All free spirits ought to congregate on an occasion like this to do homage to the greatness of America as illustrated by the greatness of her sons.
It has been a privilege, ladies and gentlemen, to come and say these simple words, which I am sure are merely putting your thought into language. I thank you for the opportunity to lay this little wreath of mine upon these consecrated graves.
You can find the full version of this speech here: www.presidency.ucsb.edu/documents/memorial-day-address
Correction Incoming?
Markets are doing their thing again, so let’s discuss.
Markets tumbled, heading into negative territory, and then bounced back. And then promptly fell again.1
We’re caught in a whipsaw pattern of uncertainty.
Is this weird?
Not really. These things happen pretty regularly when investors get jittery.
Let’s talk about what’s going on.
(Scroll to the end if you just want our takeaways.)
What led to the selloff?
Phew. There’s a lot going on.2
There’s yet another debt ceiling deadlock between Congress and the White House.
Worries about the banking sector continue.
Sticky inflation is still on everyone’s radar.
And then there’s the endless speculation about recessions and what the Federal Reserve might do next.
All these stressors lead to jumpy investors and nervous markets.
Could we see another serious correction?
Absolutely. If the debt ceiling standoff drags on or more bad headlines appear, markets could react negatively.
And, corrections and pullbacks happen very frequently because there’s always something going on.
How often? Let’s go to the data.
Here’s a chart that shows just how often markets dip each year. (You may have seen this chart before because it’s an oldie and goodie.)
Take a look at the red circles to see the market drops each year.
The big takeaway? In 15 of the last 23 years, markets have dropped at least 10% each year.3
Market pullbacks happen all the time.
We’re dealing with a lot of uncertainty and investors are feeling cautious.
However, that doesn’t mean that we should panic and rush for the exits.
Markets are going to be turbulent this year and knee-jerk reactions can be costly.
We don’t have a crystal ball, so we don’t know how it’s all going to play out, but this situation isn’t surprising.
We expected volatility and we’re prepared.
We’re watching markets closely. Any questions or concerns we can address? Let us know. We’re here to help.
Sources
The Duality of the Markets
Have you ever noticed how so many idioms refer to the duality of life? Consider: There are two sides to every coin. Life is a double-edged sword. You can see the glass as half-full or as half-empty. Every cloud has a silver lining.
Each of these sayings refers to the fact that almost everything in life can be seen as either good or bad; it’s all based on what we focus on. Sometimes, it can even depend on which “side” we see, hear, or learn about first. Even science has found this to be true. For example, in 2014, two psychologists named Angela Legg and Kate Sweeny ran an interesting study. Two groups of people filled out a personality inventory. The first group was told they would get feedback, some positive, some negative. The second group learned that they would be the ones to give it.
The study found that 78% of the people in the first group wanted to hear the negative stuff first.1 That’s because they believed that if they got the bad news out of the way, they could end on a good note, and their day wouldn’t be ruined.
The second group – the ones giving the feedback – were divided. Roughly half focused on what they thought the recipient would want to hear and decided to give the bad news first. The other half focused on their own feelings and decided to give the good news first, because they felt it would be easier to start off with something positive. Either way, just about everyone in the study was preoccupied with the order in which to face both sides of the situation. It didn’t matter if both the good and bad were roughly equal. What mattered was mindset.
We were thinking about this recently while pondering our next market message. The very message, in fact, that you are reading now. You see, there is a real duality to the markets at the moment. Storylines pulling the markets down, storylines pushing them back up. But which to focus on? Which to start with?
Given what we learned from that study we mentioned, we think we’ll start with the “bad” news before sharing the “good.” Then, we’ll explain why, when you think about it, it really doesn’t matter.
Interest Rates and Bank Failures
Perhaps the biggest drag on the stock markets – not just now but over the last year – has been the steady rise of interest rates. The most recent hike came on May 3rd, bringing rates to a 16-year high of 5.25%.2 Essentially, the Fed has spent the last year trying to combat inflation by cooling down the economy. When rates are low, consumers and businesses are incentivized to borrow and spend. But when rates are high, it’s meant to reward saving overspending. If people spend less and demand for goods and services goes down, companies have little choice but to lower prices if they’re to attract new business.
Unfortunately, these rate hikes are very much a – wait for it – double-edged sword. Because while they do serve as a deterrent against inflation, they can depress economic activity to the point of a recession. This fear of a recession, accompanied by lower earnings from many companies as a result of higher interest rates, has triggered some of the volatility we’ve seen in recent months.
But rising interest rates have done something else, too: Threaten the solvency of America’s banks.
On March 10, federal regulators seized Silicon Valley Bank, the sixteenth largest in the country. Two days later, New York’s Signature Bank collapsed. And on May 1st, First Republic Bank in San Francisco was seized, too, with most of its assets promptly sold to JPMorgan Chase. Given how suddenly – and consecutively – these regional banks fell, many investors have been gripped by fear of contagion spreading across the entire banking industry.
While none of these situations were exactly the same, all three banks had certain things in common. For one, all made long-term investment bets that turned out to be far too risky. In the case of Signature Bank, this was in cryptocurrency, the value of which has plummeted in recent months. In the case of Silicon Valley and First Republic, it was placing far too much money in U.S. Treasury bonds. When interest rates began rising, the value of these bonds fell. Suddenly, these banks held most of their money – their depositors’ money – in assets that no one wanted. Furthermore, all these banks had an unusually high number of uninsured deposits. As a result, customers began withdrawing their money in droves. No bank can survive without deposits, forcing the government to step in and take over before everyone lost everything.
Now, three banks – out of the thousands that exist in the U.S. – may not sound like much. But since this started, investors have been combing the industry with a magnifying glass, trying to find which other firms might have hidden weaknesses. This has caused many banks’ stock prices to fluctuate wildly in recent weeks, acting as a further drag on the markets as a whole. It’s also added to recession fears. That’s because regional banks like these play a vital role in helping families, local businesses, and startups participate in the broader economy.
In each of these cases, the government has acted quickly in order to prevent any contagion from spreading. So, if all this banking turbulence stops with First Republic, well and good. But if other regional banks experience more credit shocks or a fire sale on their stock prices, this may well be a case of getting out of the frying pan only to fall into the fire. Stay tuned.
So, that’s the “bad news”. Now, let’s turn to a new subject that could be seen as either good or bad, depending on how you look at it.
Inflation
Since 2021, inflation has been the root cause of almost every bit of economic uncertainty. But the role inflation plays has changed over time.
The current spike in inflation started due to an explosion of economic activity after the COVID-19 lockdowns. Buoyed by historically low interest rates, Americans were shopping again, and not just for distractions to keep them busy while they were stuck at home. But this pent-up demand far exceeded supply, causing prices to skyrocket. Later, inflation became more driven by snarls in global supply chains. Then, it became exacerbated by the war in Ukraine. All these factors simply made it very difficult – and expensive – to get goods where they needed to be.
Lately, though, inflation has changed again. Now, the single biggest factor is not the price of goods, but of services. People aren’t just buying things again; they’re doing things again. Eating out at restaurants, going to sporting events, putting their children in daycare, and traveling. Meanwhile, a strong labor market has led to extremely low unemployment and rising wages. This has caused businesses to raise prices to compensate.
For these reasons, inflation remains stubbornly high, even after a year of rising interest rates. But here is where you can see the glass as either half full or half empty. The half-empty view would be that inflation remains high, meaning the Fed could keep raising rates. But the half-full view is that these same factors keeping inflation high are also keeping us out of a recession. (More on this in a moment.) Then, too, prices are coming down…just very, very slowly. (Back in March, prices were up 5% compared to the same time last year; that’s down from the 6% mark we saw in February.3)
Finally, let’s get to the “good” news…unless, of course, you’re the Federal Reserve, proving that even good news can be a double-sided coin.
Jobs
For months, analysts have predicted the labor market would slow down. Because of higher interest rates, companies would stop hiring, or even lay off workers. To be frank, this is what the Federal Reserve wants – at least to a degree. Because it’s this sort of economic cooldown that will tamp down prices. But it’s also been a main source of recession-based fears. When unemployment starts rising, a recession is often not far behind.
To date, however, it hasn’t happened. In April alone, the economy added 253,000 jobs. That’s far more than what most economists predicted. In fact, it’s brought the unemployment rate even lower, to 3.4%. That matches a 53-year low!4
This is terrific news. The more jobs there are, the more spending there is. The more spending there is, the more the economy will grow…or at least, not contract to the point of a recession. But unbelievable as it may seem, there is a counterargument. These job numbers may prompt the Fed to keep raising rates if they believe the economy can handle it…thereby injecting more uncertainty into the stock market and bringing us closer to a recession. Only time will tell which way investors decide to spin it.
The Takeaway
So, what are you thinking right now? Are you feeling positive or negative about the markets? On the one hand, we devoted more words to the “bad” news. On the other, we finished with a (mostly) positive note, with lower inflation and higher employment.
To be honest, however you react to all this says more about you – and more about how we wrote this message – than about the markets themselves. And that is exactly the point.
Positive and negative. Good news and bad. Yin and yang. Jekyll and Hyde. Dark side and light side. Half-full and half-empty. The fact is, there are two sides to almost every storyline impacting the markets right now. And most investors are picking and choosing what they react to, and how they react, based on which side of that duality they fall on. They choose one side of the coin, one edge of the sword. They turn investing into one big psychology experiment.
But we’re not most investors.
Moving forward, we need to accept that there are forces pushing the markets up and forces pulling the markets down. We can’t control which of those forces wins. Nor can we predict, day to day, which force will prove stronger. This is precisely why we have chosen a long-term strategy for investing. We don’t have to decide whether the glass is half-full or half-empty. We don’t have to stress over whether we hear the good news or the bad news first. We acknowledge both as important…but neither as everything. We don’t have to worry about guessing right because we never guess. Instead of guessing, we take a measured approach of analyzing the data, identify the areas of strength and weakness and make portfolio changes as necessary. As always, our team will keep watching all these storylines closely. In the meantime, our advice is to not stress about whether tomorrow’s news will be good or bad. We are always here to help you hope for the one and plan for the other…while remembering the words of one of our favorite idioms: Slow and steady wins the race.
1 “Why Hearing Good News or Bad News First Really Matters,” PsychologyToday, June 3, 2014. https://www.psychologytoday.com/us/blog/ulterior-motives/201406/why-hearing-good-news-or-bad-news-first-really-matters
2 “Fed increases rates a quarter point,” CNBC, May 4, 2023.
https://www.cnbc.com/2023/05/03/fed-rate-decision-may-2023-.html
3 “Inflation Cools Notably, but It’s a Long Road Back to Normal,” The NY Times, April 12, 2023. https://www.nytimes.com/2023/04/12/business/inflation-fed-rates.html
4 “US labor market heats back up, adding 253,000 jobs in April,” CNN Business, May 5, 2023. https://www.cnn.com/2023/05/05/business/april-jobs-report-final/index.html
A Brief Update on the Debt Ceiling
On May 1, the Secretary of the Treasury informed Congress that the U.S. could default on its debt by June 1 if legislators do not raise the nation’s debt ceiling.1
This announcement was not a surprise. The U.S. officially hit the debt ceiling in January but were able to stave off any immediate effects using “extraordinary measures.” (These are essentially accounting tools the government can use to pay its bills without authorizing any new debt.) The Secretary’s recent message was to let Congress know those measures are close to being exhausted. Without raising the debt ceiling, the U.S. will not have the money it needs to pay its debts. And while the exact date this will happen is unknown, it could come by June 1 at the earliest.
Should a default happen, the economic consequences could be severe. But even if Congress staves off the unthinkable, simply going down to the wire can have negative effects on the markets. To explain why that is, it’s useful to first remind ourselves what the debt ceiling is.
The debt ceiling is “the total amount of money that the government is authorized to borrow to meet its existing legal obligations.”2 What are these obligations? It’s a massive list. Think Social Security and Medicare benefits, for starters. Tax refunds, military salaries, and interest payments on Treasury bonds are hugely important, too. The debt ceiling, then, is the limit to what the government can borrow to pay back what it has already spent. (Or is legally obligated to spend.)
Normally, raising the debt ceiling requires a simple act of Congress. But in some years, politicians disagree about whether the ceiling should be raised without an accompanying decrease in spending. That’s the scenario we’re in right now. Congressional Republicans do not want to raise the debt ceiling without enacting spending cuts at the same time. Democrats, meanwhile, prefer a “clean” hike where the ceiling is raised without conditions. In their view, any changes to federal spending should come separately, after the nation’s existing debts are addressed.
In other words, the two sides of the political aisle are engaged in a game of fiscal “chicken.” Each betting the other will blink first.
The problem with this game is that at some point, if a resolution isn’t reached, everyone loses. While no one is quite sure what will happen if the U.S. defaults – it’s never happened before – it’s not hard to guess, either. Look at that list of obligations we mentioned earlier. Now, imagine if they all just…stopped. No Social Security checks. No Medicare payments. No tax refunds. Tens of thousands of soldiers and government employees without income. And don’t discount the importance of interest payments on Treasury bonds. Without this, interest rates would skyrocket and probably lead to a major recession.
Now, it’s important to note that this is not our country’s first rodeo with the debt ceiling. This has actually happened several times over the past twelve years. In each instance, Democrats and Republicans eventually came to an agreement and raised the ceiling. Most experts expect the same thing to happen this time.
That said, the two sides are still very far apart. While House Republicans have made a proposal on the cuts they want to see, most are measures that Democrats are unlikely to agree to. (The bill would lift the debt ceiling by $1.5 trillion through March of 2024 while eliminating $130 billion in government funds. But that’s not a very long time, and most of the cuts are to areas that the White House considers high priority.3) The two sides have agreed to a meeting on May 9, but it’s doubtful whether that will lead to anything.
The closer we get to June; however, the more nervous Wall Street will get. Given how much uncertainty already exists in the markets – thanks to rising interest rates and a recent spate of bank failures – a debt ceiling crisis is the last thing investors need. To be sure, there are other possible outcomes to this situation. Perhaps the most likely is that Congress enacts a short-term increase to the borrowing limit. This would give themselves more time to pass something longer lasting. It would also be seen as kicking the can further down the road…and not much further at that!
If the U.S. does default, there may be ways to blunt the impact. For instance, the government could prioritize its debt payments so that not everyone gets left out in the cold all at once. Another possibility would be for the Federal Reserve to buy up more Treasury bonds. This would at least stabilize the bond market. But none of these options are ideal, and it would be best for everyone to avoid them.
So, that’s where things stand. In the coming weeks, we’ll post more detailed information on what hitting the debt ceiling could mean for investors. (Assuming Congress doesn’t get its act together before then.) In the meantime, our team will continue to monitor the situation carefully.
As always, please let us know if you have any questions, or if there is anything we can do for you!
1 “Treasury’s Yellen says US could default as soon as June 1,” The Associated Press, May 1, 2023. https://apnews.com/article/x-date-debt-ceiling-yellen-treasury-borrowing-f726fd88a9bb7f72e50f0b948731ac57
2 “Debt Limit,” U.S. Department of the Treasury, https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/debt-limit
3 “No Solution in the Senate,” Politico, May 1, 2023. https://www.politico.com/news/2023/05/02/senate-parties-debt-00094873
Questions You Were Afraid to Ask #8
The only bad question is the one left unasked. That’s the premise behind many of our recent posts. Each covers a different investing-related question that many people have but are afraid to ask. Last time, we answered the question, “What’s the difference between the various types of bonds?” Now, we’d like to continue in that vein by answering:
Questions You Were Afraid to Ask #8:
What on earth do all these bond terms mean?
One common frustration investors have is dealing with all the terms and jargon used in the financial industry. Ever hear two Wall Street types talking? It can be like listening to a bad episode of Star Trek!
Bonds come with a lot of lingos which can be very intimidating for investors. So, in this message, let’s break down a few common terms you’re likely to hear in the media or when thinking about investing in bonds.
As we covered in our last message, when you buy a bond, you are lending money to an issuer. In return, the issuer promises to pay you a specified rate of interest on a regular basis, and then return the principal when the bond matures. In this paragraph alone, we can find four common terms: issuer, par value, coupon rate, and maturity.
Issuer: This is the entity that “issued” the bond to borrow money. Generally, issuers include local and state governments, the U.S. Treasury, and corporations. Whoever it is, it’s their responsibility to make interest payments and repay the amount you initially loaned. This brings us to:
Par Value: This is the amount that must be returned to the investor when the bond matures – essentially, the investor’s principal. (Many bonds are issued at a par value of $1,000.) Note that it doesn’t matter whether the bond matures in 10, 20, or 30 years. Whenever that time is up, the issuer would still pay back the initial par value. You may also occasionally see the term “face value” instead of par.
Coupon Rate: This is the bond’s interest rate, paid by the issuer at specific intervals. For instance, let’s say you owned a $1,000 bond with a 5% coupon rate. The issuer would then pay you $50 in interest each year until maturity. (Note that some bonds pay interest semiannually. In such cases, you would be paid $25 every six months, which of course equals the same $50 in interest per year.)
You may be wondering how coupon rates are determined. There are two main factors: the amount of time to maturity, and the credit rating of the issuer. Typically, bonds that take longer to mature come with higher rates. After all, investors want compensation for not getting their principal back until later. Conversely, bonds with shorter maturities usually pay lower interest rates. Furthermore, if the issuer has a low credit rating – meaning there is some risk that they may not be able to repay their creditors – they will usually pay higher interest rates to compensate for the additional risk.
So, why is it called a “coupon” rate? Once upon a time, investors were given actual, physical coupons to redeem to collect their interest payments.
Maturity: This term is simple. You’ve probably figured it out already. This is the amount of time until the bond is due to be repaid. A 10-year Treasury bond, for instance, matures 10 years from the date it was issued.
Rating: As mentioned, some issuers have higher or lower credit ratings. An issuer rating signifies the bond’s credit quality. Here in the United States, there are three main rating services: Standard & Poor’s, Moody’s Investor Services, and Fitch Ratings Inc. Each agency rates bonds based on the issuer’s potential ability to pay both interest and principal in a timely fashion.
Price: Hopefully, all these terms have been easy to understand, because here is where things get a little tricky. As you know, bonds can be traded on the open market. For example, let’s say Fred buys a bond, but before it matures, decides to sell it to Fran. The “price” is the amount for which the bond is traded. Sometimes, bonds trade at their par value, but they don’t have to be. For instance, imagine Fred bought his bond for $1000, but trades it to Fran for only $950. The bond’s price, then, is $950, and is said to be traded at a discount. On the other hand, if Fred trades it for $1,050, then Fran would be buying it at a premium.
Why would a bond’s price differ from its par value? Sometimes, due to rising or falling interest rates. For example, if interest rates around the country rise above what they were when the bond was issued, that bond would no longer be as valuable. That’s because the old bond’s coupon rate would be lower than what an investor could get if they bought a new bond. Hence, if Fred wanted to sell his bond before maturity, he would have to do so at a discount.
There is one final bond-related term you should know – yield. In fact, this is probably the one you’re most likely to hear about in the media. Unfortunately, it’s also a little too complex to define in a paragraph or two, so it’ll be the sole subject of next month’s letter.
In the meantime, we hope this message helped demystify some of the lingo around bonds. As you can see, most of these terms aren’t really that complex once you translate them into plain English. Have a great day!
Q1 Market Recap
Have you ever heard the stock market be compared to a roller coaster? There’s a good reason for this. While sometimes the markets will go through long, relatively flat periods, there are also times when they will rise and fall, climb and dip with astonishing speed.
The first quarter of 2023 was the perfect example of this.
As you know, last year was a turbulent one for investors. Inflation worries, rising interest rates, oil prices, and the war in Ukraine all combined to drag the S&P 500 down 19.4% for the year.1 In fact, it was the worst 12-month span since the financial crisis of 2008.
The good news is that stocks bounced back somewhat in Q1. But this is where the roller coaster analogy really kicks in.
For example, in January, the S&P 500 rose just over 6.5%.2 But in February, the markets dropped 2.6%.2 Things got bumpy in early March, as the S&P rattled up and down like one of those old, wooden roller coasters from the early 20th century. But the markets hit a hot streak toward the end of the month, and as a result, the S&P finished up 7% for the quarter. 3
Some sectors did even better than this. For example, tech stocks – which got hammered in 2022 – have enjoyed a much more positive start to the year. In fact, the Nasdaq, an index made up largely of tech stocks, shot up nearly 17%!3
A roller coaster, indeed.
So, what was behind the market’s latest thrill ride? There are a few factors, but chief among them is the Federal Reserve’s war on inflation. After some data suggested that inflation began cooling off in late 2022, the Federal Reserve started cooling off the rate at which it’s been raising interest rates. In both February and March, the Fed hiked rates by only 0.25%.4 That’s far less than the 0.75% hikes we were seeing previously. This has led many investors to hope the Fed won’t raise rates as high as economists expected.
There are two reasons this matters. First, the higher interest rates go, the greater the chances of our economy entering a recession. Second, higher rates tend to eat into corporate earnings.
Put these two together, and it’s clear why the expectation of lower interest rates – or at least, slower rate hikes – would boost investor confidence.
So, what does all this mean moving forward? Is the roller coaster coming to an end? Is the car pulling into the station?
This is an important time to remember that current market conditions don’t reflect the present – they reflect expectation of the future. Investors expect the Fed to stop hiking rates, so investor confidence goes up. But there are many factors that could cause those same expectations to change in a heartbeat. For example, inflation is still an issue, and there’s no guarantee the Fed won’t keep hiking rates if prices remain high. (Indeed, oil prices are on the rise again, which means other prices could rise as a result.)
Here’s something else to keep in mind. While the S&P 500 rose 7% for the quarter, raw numbers like that don’t always tell the full story. Much of that rally was driven by a small group of stocks overperforming – mainly the aforementioned tech companies. But, as its name suggests, the S&P 500 contains five hundred companies…and most of them barely moved at all. The rally, in other words, was not broad, but narrow.
While it has certainly been nice to see the markets trending up again after such a rough 2022, it’s important that we do not get carried away by a few months of growth driven by relatively few companies. In other words, it’s important we don’t try to get off the ride before the roller coaster has come to a complete stop.
You see, the roller coaster metaphor isn’t important because it’s cute. It’s because it contains good advice. When you board a real roller coaster, you always know generally what to expect. You know it’s going to be bumpy, jerky, fast. You know there are going to be sharp turns that whip your head around and sudden drops that make the pit fall out of your stomach. So, what do you do? You secure your valuables. You buckle your seat belt. You brace yourself. As investors, it’s important that we keep doing that moving forward – so that, ultimately, we end up at the destination we want, having enjoyed the ride.
We’ll continue to be cautious, especially in the short term, keeping our hands and legs inside the vehicle until we get a clearer view of what’s in front of us. And our team will keep watching our clients’ portfolios, doing our best to make the ride as smooth and straight as possible.
As always, if you have any questions or concerns about the markets, please let us know. In the meantime, have a great week, a great quarter, and a great Spring!
1 “Stocks fall to end Wall Street’s worst year since 2008,” CNBC, https://www.cnbc.com/2022/12/29/stock-market-futures-open-to-close-news.html
2 “S&P 500 Index Historical Prices,” The Wall Street Journal, https://www.wsj.com/market-data/quotes/index/SPX/historical-prices
3 “Stocks Close Higher in Last Session of Turbulent Quarter,” The Wall Street Journal, https://www.wsj.com/articles/global-stocks-markets-dow-update-03-31-2023-2eafbb02
4 “The Fed announces ninth-straight interest rate hike of 25 basis points,” CNBC, https://www.cnbc.com/2023/03/22/fed-announces-interest-rate-hike-of-25-basis-points.html
Questions You Were Afraid to Ask #7
Some time ago, we wrote a series of posts called “Questions You Were Afraid to Ask.” Each one answered a common question many investors have but feel uncomfortable asking.
When we were young, we were taught that “The only bad question is the one left unasked.” As financial advisors, we’ve found that statement to be true! Every day, our clients ask us questions about the markets, taxes, their personal finances, you name it. Over the course of our careers, we have never thought, “That’s a stupid question.” Not once. That’s because stupid questions simply don’t exist!
Lately, several friends and acquaintances who were also receiving our articles asked us to start the series up again. Since we love helping people in our communities learn more about how finance works, we’re happy to do it. So, without further ado, let’s answer:
Questions You Were Afraid to Ask #7:
What’s the difference between all these types of bonds?
When you buy a bond, you are lending money to the issuer – generally a company or government. In return, the issuer promises to pay you a specified rate of interest on a regular basis, and then repay the principal when the bond matures after a set period of time.
As you know, the markets had a very up-and-down year in 2022. Whenever that happens, many investors start showing renewed interest in bonds, because they tend to be less volatile than stocks. This interest may continue in 2023. But there are several types of bonds to choose from, each with different characteristics. All those options can be confusing, so we figured now would be a good time to give people a brief overview of the main types that investors have to choose from. Let’s start with:
Corporate Bonds
Corporate bonds are issued by both public and private corporations. Companies use the proceeds of these bonds to buy new equipment, invest in new research, and expand into new markets, among other reasons. These bonds are usually evaluated by credit rating agencies based on the risk of the company defaulting on its debt.
Corporate bonds can be broken down into two sub-categories: Investment-grade and High-Yield. Investment-grade bonds come with a higher credit rating, implying less risk for the lender. They’re also considered more likely to make interest payments on time than non-investment grade bonds.
High-yield bonds have a lower credit rating, implying higher risk for the investor. These are typically issued by companies that already have more debt to repay than the average business or are contending with financial issues. Newer companies may also issue high-yield bonds, because they simply don’t have the track record yet to garner a high credit rating.
In return for this added risk, high-yield bonds typically pay higher interest rates than investment-grade bonds. In short, investment-grade implies lower risk for a lower return; high-yield implies higher risk for a higher return.
Muni-Bonds
Municipal bonds, or “munis”, are issued by states, cities, counties, and other government entities so that entity can raise funds. Sometimes these funds are to pay for daily operations like maintaining roads, sewers, and other public services. Sometimes the funds are to finance a new project, like the building of a new school or highway.
Muni-bonds can also be broken down into two sub-categories: Revenue bonds and general-obligation bonds. The former are backed by the revenues from a specific project, such as highway tolls. The latter are not secured by any asset but are instead backed by the “full faith and credit” of the issuer, which has the power to tax residents in order to pay bondholders, should that ever be necessary.
In other respects, muni-bonds work similarly to corporate bonds in that the holder receives regular interest payments and the return of their original investment. But they do come with one additional advantage, in that the interest on muni-bonds is exempt from federal income tax. (It may also be exempt from state and/or local taxes if the holder resides in the community where the bond is issued.) However, muni-bonds often pay lower interest rates than corporate bonds do.
U.S. Treasuries
Treasury bonds are the type of bonds you usually hear about in the news. As the name suggests, these are issued by the U.S. Department of Treasury on behalf of the federal government. They carry the full faith and credit of the government, which has historically made them a very stable and popular investment. In fact, U.S. treasuries tend to be so stable that economists often use them as a bellwether for the overall health of the entire economy.
There are several types of U.S. Treasury bonds. Treasury Bills are short-term bonds that mature in a few days to 52 weeks. Treasury Notes are longer-term securities that mature in terms of 2, 3, 5, 7, or 10 years. Finally, actual U.S. Treasury Bonds typically mature every 20 or 30 years. Both Notes and Bonds pay interest every six months.
Finally, we have Treasury-Inflation-Protected Securities, or TIPS. These are notes and bonds whose principal is adjusted based on changes in the Consumer Price Index, which tracks inflation. Interest payments are made every six months and are calculated based on the inflation-adjusted principal. That means if inflation goes up, so too does the principal in the bond…thereby increasing the amount of interest that is paid. However, if inflation goes down, the principal does too, thereby decreasing the interest rate.
Bonds are an important subject that all investors should know about, so we hope this overview was helpful! In our next post, we’ll break down some of the terms you will often see associated with bonds that many investors find confusing. In the meantime, happy spring!
A Run on the Bank – a Situation Update
Volatility in the banking industry almost always means volatility in the markets, and there was a lot of both last week.
As you know, Silicon Valley Bank (SVB) was seized by federal regulators on Friday, March 10. It was not the first bank to collapse this month, nor was it the last. Two days earlier, Silvergate Bank, another California institution, announced it would liquidate its assets and wind down operations. And two days after the SVB collapse, regulators closed a third bank. This was Signature Bank, based out of New York.
What do these banks have in common, besides sharing a similar fate? Well, all three were hit by bank runs in the days prior to their collapse. All three had made ill-timed investments in recent years. For Silvergate and SVB, this was in the form of overexposure to government bonds, which dropped in value as interest rates skyrocketed. For Signature – and Silvergate, too – the trouble really started when the price of bitcoin and other cryptocurrencies plummeted in 2022.
Over the weekend, investors, not to mention the many companies with their deposits on hold, waited with bated breath to see what the government’s response would be. After all, everyone still remembers what happened in 2008. Back then, panic spread across the entire banking industry – and from there to the overall economy. Unfortunately, some of that panic came because the government stepped in and then didn’t, which left investors with uncertainty.
“Contagion” is a very real thing when it comes to banking, and no one wants a repeat of the financial crisis. In recent days, other banks that have not collapsed, have strong balance sheets, and are not necessarily in danger, still saw their stock prices fall dramatically. This partly came due to how connected individual stocks are with index fund trading and partly because investors run if they catch even a whiff of financial instability.
As it turns out, Washington moved swiftly and decisively to stamp out uncertainty. On March 12, the Federal Reserve created the Bank Term Funding Program. This program will provide emergency loans for up to one year to safeguard 100% of deposits to any bank or credit union that needs it.1 (Normally, only the first $250,000 of an account’s deposits were insured against loss. Most of the organizations doing business with these three banks stood to lose much, much more than that.) In return, these banks must put up any Treasuries or highly rated debt they own as collateral and pay a modest interest rate.
The idea here is to stabilize all the regional banks around the country by assuring customers their money is safe. Furthermore, the program is designed to make it easier for banks to get needed liquidity instead of selling their assets off in a fire-sale.
A couple things to note about this program:
First, this is not a “bank bailout” in the traditional sense. The banks themselves are not being saved or spun off to other, larger banks. Furthermore, both bond- and stockholders of these banks will still likely experience a loss in the short term. This program is designed solely to protect depositors. (Of course, the exact definition of a “bailout,” and whether one is justified or not, is a topic best left to politicians.)
Second, to pay for all this, the government will draw from the Deposit Insurance Fund. This fund comes from quarterly fees levied on financial institutions. Public taxes will not be used.2
So, what does all this mean for the future? What does it mean for us?
There are several things we as investors need to be aware of:
- More volatility. The government’s actions temporarily stabilized the markets early in the week. But the major indices dropped again on Wednesday when an important European bank was found to be in financial difficulty, albeit for different reasons and has been in decline long before these failings. In the short term, investors will be hypersensitive to any banking instability. That means volatility is still very much in the cards.
- Politicization. Right now, politicians and pundits on both sides of the aisle are trying to turn this issue into the latest political football. As investors, we must avoid getting caught up in all that and remain focused on keeping to our investment strategy.
- Interest rates. There’s a lot of chatter on Wall Street right now that this issue will cause the Federal Reserve to delay more interest rate hikes. If that happens, it’s quite possible the markets will go up. But we do not make guesses about which way the markets will go or what the Fed will do. In fact, you can make an argument that doing so is partly why SVB got into so much trouble.
So, that’s where things stand right now. Obviously, there’s a lot our team will be monitoring in the coming weeks. In the meantime, our advice to you is to enjoy the start of Spring! Whenever anything changes, we’ll let you know immediately. And as always, do let us know if you have any questions or concerns.