Quote of the Week
“Power doesn’t corrupt as much as it reveals.” — Robert Caro
The markets took a breather last week. The Dow was off -0.91%, the S&P 500 was down -1.48%, and the Nasdaq was down -1.54%. The year to date, the Dow is up +0.68%, the S&P 500 is up +0.32%, and the Nasdaq is up +0.86%. I hope you would check your accounts to see how you are doing with us this year.
After Wednesday, we will have a new President. Mr. Biden has proposed a bold financial plan of $1.9 trillion to get the economy jump-started going forward. I don’t know if he can get it through the Senate, but it could help the stock market if he gets anything passed. Let’s get through the inauguration without any more domestic terrorism and let Mr. Biden and the Congress get to work.
Last week I published the Economic Outlook for the first quarter. Some of you missed it, so we are posting it again. Things look good for the markets going forward. If the data changes, we will change the portfolios. But for now, we have positioned the portfolios for a rising stock market.
Now to repeat our outlook message:
As I have been saying for the last few months, we are solidly in economic Quad II. Quad II is characterized by growth increasing and inflation increasing. Quad II, along with Quad I (growth increasing, inflation declining), are the best quadrants for making money. Quad II is especially good for stock prices and commodity prices increasing. So with our portfolios, we have “skated to where the puck is going to be,” and we have been there since the middle of November of 2020.
The data is saying that this is a powerful Quad II. What is really exciting is that the rest of the world is also in Quad II. Based on the data showing the strength of the economic recovery, we and the rest of the world should stay in Quad II through the second quarter of 2021. So it looks like “smooth sailing” at least until June or July.
We believe there should be good news going forward. As tracked by the Gross Domestic Product (GDP), the economy is expected to grow year over year by +11%. This is the largest GDP growth since the end of World War II.
Many things are causing this growth.
First, we have robust consumer demand coming soon. As the effect of the increased vaccine deployment, people will start to come out of their sequestration and begin to spend on things they were unable to spend on for the last ten months. Restaurants, cruise lines, hotels, and most consumer discretionary items will be in high demand. It will be like we have just gotten out of jail, and we will take advantage of our freedom. During the last ten months, people have drastically cut back on consumer discretionary items because they couldn’t spend on them. Now, add this to the mix, since March 2020, Americans have saved 1.55 trillion dollars. This is an immense amount of money waiting to be spent. The University of Michigan says that spending expectations are at a four-year high.
Second, consumer goods inventories are low. This means that a lot of stuff needs to be produced to meet the coming spending wave’s demand. That means that the companies making those goods will increase their revenues. The corporate profit cycle over the next 12 months is expected to increase by over 30%. Remember, higher profits mean higher stock prices.
Third, the Fed is pumping more than $120 billion into the economy every month. More money into the system means there is more money to spend. I don’t see this stopping. President-elect Biden has sent a strong message to the markets by appointing Janet Yellen to be Treasury Secretary. Plus, add in Cecilia Rouse’s appointment to be the head of the Council of Economic Advisors. Those two, along with the Fed chairman Jerome Powell are poised with a mission to address the economic inequality in America. That means the economic floodgates will be wide open to boost the economy.
Ok, where should we be invested to take advantage of “where the puck is now.” First, let’s start where not to be invested. We are currently taking a step away from bonds. With inflation increasing interest rates will be rising, and when interest rates rise, bond values go down. We have already seen that happen. If you are going to refinance or get a new home mortgage, the window is closing.
We are also avoiding Real Estate Investment Trusts and Utilities. Because REITs and Utilities pay a fixed dividend, they act like bond substitutes. Gold is another investment we are avoiding. Gold doesn’t pay interest or dividends, so when interest rates rise, fixed-income investments become more attractive, so investors move out of Gold.
Where do we go? In Quad II, we want to take advantage of inflation, so we invest in commodities, including energy. Because the dollar is going down, we want to invest in currencies of other countries.
Finally, with the economy improving and the consumer’s pent-up demand, and the $1.55 trillion in consumers’ pockets, we want to be in the stock market.
Individual situations may vary. Please give us a call at 520-881-2523.
I found the following article interesting and thought I’d share it with you this week.
Revisiting the 4% Rule
Saving for retirement is not easy, but using your retirement savings wisely can be just as challenging. How much of your savings can you withdraw each year? Withdraw too much and you run the risk of running out of money. Withdraw too little and you may miss out on a more comfortable retirement lifestyle.
For more than 25 years, the most common guideline has been the “4% rule,” which suggests that a withdrawal equal to 4% of the initial portfolio value, with annual increases for inflation, is sustainable over a 30-year retirement. This guideline can be helpful in projecting a savings goal and providing a realistic picture of the annual income your savings might provide. For example, a $1 million portfolio could provide $40,000 of income in the first year with inflation-adjusted withdrawals in succeeding years.
The 4% rule has stimulated a great deal of discussion over the years, with some experts saying 4% is too low and others saying it’s too high. The most recent analysis comes from the man who invented it, financial professional William Bengen, who believes the rule has been misunderstood and offers new insights based on new research.
Bengen first published his findings in 1994, based on analyzing data for retirements beginning in 51 different years, from 1926 to 1976. He considered a hypothetical, conservative portfolio comprising 50% large-cap stocks and 50% intermediate-term Treasury bonds held in a tax-advantaged account and rebalanced annually. A 4% inflation-adjusted withdrawal was the highest sustainable rate in the worst-case scenario — retirement in October 1968, the beginning of a bear market and a long period of high inflation. All other retirement years had higher sustainable rates, some as high as 10% or more. 1
Of course, no one can predict the future, which is why Bengen suggested the worst-case scenario as a sustainable rate. He later adjusted it slightly upward to 4.5%, based on a more diverse portfolio comprising 30% large-cap stocks, 20% small-cap stocks, and 50% intermediate-term Treasuries. 2
In October 2020, Bengen published new research that attempts to project a sustainable withdrawal rate based on two key factors at the time of retirement: stock market valuation and inflation (annual change in the Consumer Price Index). In theory, when the market is expensive, it has less potential to grow, and sustaining increased withdrawals over time may be more difficult. On the other hand, lower inflation means lower inflation-adjusted withdrawals, allowing a higher initial rate. For example, a $40,000 first-year withdrawal becomes an $84,000 withdrawal after 20 years with a 4% annual inflation increase but just $58,000 with a 2% increase.
To measure market valuation, Bengen used the Shiller CAPE, the cyclically adjusted price-earnings ratio for the S&P 500 index developed by Nobel laureate Robert Shiller. The price-earnings (P/E) ratio of a stock is the share price divided by its earnings per share for the previous 12 months. For example, if a stock is priced at $100 and the earnings per share is $4, the P/E ratio would be 25. The Shiller CAPE divides the total share price of stocks in the S&P 500 index by average inflation-adjusted earnings over 10 years.
Again, using historical data — for retirement dates from 1926 to 1990 — Bengen found a clear correlation between market valuation and inflation at the time of retirement and the maximum sustainable withdrawal rate. Historically, rates ranged from as low as 4.5% to as high as 13%, but the scenarios that supported high rates were unusual, with very low market valuations and/or deflation rather than inflation. 3
For most of the last 25 years, the United States has experienced high market valuations, and inflation has been low since the Great Recession. 4-5 In a high-valuation, low-inflation scenario at the time of retirement, Bengen found that a 5% initial withdrawal rate was sustainable over 30 years.6 While not a big difference from the 4% rule, this suggests retirees could make larger initial withdrawals, particularly in a low-inflation environment.
One caveat is that current market valuation is extremely high: The S&P 500 index had a CAPE of 34.19 at the end of 2020, a level only reached (and exceeded) during the late-1990s dot-com boom and higher than any of the scenarios in Bengen’s research.7 His range for a 5% withdrawal rate is a CAPE of 23 or higher, with inflation between 0% and 2.5%.8 (Inflation was 1.2% in November 2020.)9 Bengen’s research suggests that if market valuation drops near the historical mean of 16.77, a withdrawal rate of 6% might be sustainable as long as inflation is 5% or lower. On the other hand, if valuation remains high and inflation surpasses 2.5%, the maximum sustainable rate might be 4.5%.10
It’s important to keep in mind that these projections are based on historical scenarios and a hypothetical portfolio, and there is no guarantee that your portfolio will perform in a similar manner. Also remember that these calculations are based on annual inflation-adjusted withdrawals, and you might choose not to increase withdrawals in some years or use other criteria to make adjustments, such as market performance.
Although there is no assurance that working with a financial professional will improve investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies, including your withdrawal strategy.
All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid.
The S&P 500 index is an unmanaged group of securities considered representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.
1-2) Forbes Advisor, October 12, 2020
3-4, 6, 8, 10) Financial Advisor, October 2020
5, 9) U.S. Bureau of Labor Statistics, 2020
7) multpl.com, December 31, 2020
Copyright 2021 Broadridge Investor Communication Solutions, Inc
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These are Larry Lof’s opinions and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Past performance is not indicative of future results. Due to our compliance review process, delayed dissemination of this commentary occurs.
The S&P 500 is an index of stocks compiled by Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. The Index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Indices mentioned are unmanaged and cannot be invested into directly.
Technical analysis represents an observation of past performance and trend, and past performance and trend are no guarantee of future performance, price, or trend. The price movements within capital markets cannot be guaranteed and always remain uncertain. The allocation discussed herein is not designed based on the individual needs of any one specific client or investor. In other words, it is not a customized strategy designed on the specific financial circumstances of the client. Please consult an advisor to discuss your individual situation before making any investments decision. Investing in securities involves risk of loss. Further, depending on the different types of investments, there may be varying degrees of risk including loss of original principal.