Bob’s Journal for 2/17/22

Some Notable Events That Grabbed My Attention This Week

How does a portfolio earn decent income and have the benefits of diversification when inflation and interest rates are rising and bond values are falling? How can you protect retirement income from falling stock prices?

We provided the answers in last week’s members-only teleforum with my special guest, Stan Haithcock, also known as Stan the Annuity Man. We also answered questions from participants and polled the those joining us about several issues.

Many members participated in the call. If you missed the teleforum or want to listen to it again, click this link.

To learn Washington’s latest plans for estate planning and taxes, view an update from my friend, David Phillips, president of Estate Planning Specialists, along with Richard Durfee of the Durfee Law Group, and Todd Phillips of Phillips Financial Services.

Don’t Buy and Hold. Rebalance.

When markets are volatile, most investors fall into one of two categories.

There are the traders and tactical investors who believe they need to change their portfolios in response to market actions.

Then, there are the buy-and-holders who are in it for the long-term. They don’t make changes in response to what’s happening in the markets and economy.

There’s also a third group that is smaller than it should be. They earn higher long-term returns with less risk.

The third group rebalances their portfolios after markets make big moves.

You should have a target asset allocation for your portfolio, whether you’re a trader, a buy-and-holder, or something else. You should know the percentage of the portfolio that should be allocated to each investment. The allocations determine the risk versus reward profile of your portfolio.

Over time, the markets will change your allocation from the target. Some assets will decline while others rise. Even when most assets are moving in the same direction, they’ll do so at different rates.

When allocations drift too far from your target, it’s time to rebalance. You want to rebalance because the risk versus reward profile of your portfolio has changed from your target. You want to return to the target profile.

Ideally, investors would have rebalanced one or more times in 2021 as stocks set a series of record highs and continued two years of very high returns. Investors would have recognized that rising stock prices increased the percentage of their portfolios that were in stocks, and that increased the risk level of their portfolios.

If you didn’t rebalance in 2021, it’s not too late to rebalance. You don’t want to risk giving back a lot of 2021’s gains. Rebalance while the portfolio still is different from your target allocation.

To rebalance, you reduce the amounts invested in assets that now exceed your target allocations and increase the percentage of the portfolio that is in other positions until returning to the target allocation or close to it.

Rebalancing might mean selling some of the holdings that have appreciated the most and buying more of other assets. Investors still in the saving phase of life don’t have to buy and sell. They can direct that their new investments be allocated to the underweighted assets until the allocation is back to the target.

A number of studies have shown that over time disciplined periodic rebalancing increases returns and reduces risk. That’s logical, because you’re selling high and buying low. If you’re wondering the action to consider taking during this volatile period in the markets, consider rebalancing your portfolio back to the target allocations.

Will Your Estate Plan be Followed?

Before executing an estate plan with restrictions or detailed rules for the future, review the case of Albert Barnes and his estate plan.

A general rule is you can put almost any restrictions and rules in your estate plan, as long as they aren’t against public policy and don’t encourage violations of the law. But there always are exceptions to legal rules.

When people leave money to charity or with the intent it will benefit more than one generation, there often are some instructions or directions about how the money is or isn’t to be used. These are known generally are directed trusts or directed bequests. Sometimes they are called conditional bequests.

The idea is that the intended recipient has to agree to follow the directions to receive the bequest, and the beneficiary can lose the property if the conditions aren’t followed over time.

The estate of Albert Barnes is an extreme case, but it shows the potential pitfalls of putting strict limits on how an inheritance can be used.

Barnes was a chemist who became very wealthy from an invention. He used his wealth to accumulate a widely admired art collection, estimated to be worth $25 billion or more today.

Barnes died in 1951 in a car accident. His widow lived until 1966. They didn’t have children. The art collection was Barnes’ pride and joy.

Barnes had little respect for the professional art community, especially the museums and officials in his neighboring Philadelphia.

In his will, Barnes established a foundation that would own and manage his art collection. But he established a lot of rules for the foundation to follow in perpetuity.

He directed that the art never would leave the facility he built for it in the Philadelphia suburbs. It also had to be displayed exactly as he arranged it at the time of his death. No pieces could be lent to other museums, and tours couldn’t be arranged to display the pieces elsewhere.

In addition, the art would be available for public viewing only one day a week and the amount that could be charged for admission was limited.

Over the following decades, the trustees of the foundation periodically went to court to have various restrictions changed or eliminated for being impractical or outdated.

Ultimately, a court ruled the collection could be moved permanently to the museum district in Philadelphia and be controlled by the art establishment Barnes disliked.

The court said the trustees showed that it was impossible to maintain the collection with the restrictions in place. The foundation needed more money to protect the collection, keep it intact and ensure it is used for education purposes as Barnes wanted. The greater purpose of using the collection for education purposes overruled the specific directions in the will.

The key lesson of the Barnes case is that it’s difficult to anticipate all the things that could happen in the future when developing an estate plan. That’s why many estate planners discourage plans that provide specific directions or restrictions on bequests, especially when there is a trust or charitable foundation that is expected to last for generations.

Instead, planners recommend that general principles and goals be established instead of detailed rules. Many estate planners also recommend that charitable trusts and foundations be required to cease operations and distribute all their money and assets after a certain period of time has passed.

The Fed and the Digital Dollar

The Federal Reserve has been studying the potential for a digital dollar, and that has generated a lot of discussion and misinformation.

Central banks around the world have been studying possible central bank digital currencies (CBDCs) since bitcoin and other private digital currencies became popular. China probably has taken the most significant steps, establishing a digital currency for certain transactions, and essentially making bitcoin illegal.

The latest news is that Fed researchers issued a paper outlining the advantages and disadvantages of a digital dollar as well as the practical limitations of establishing one.

The Fed isn’t talking about eliminating the paper dollar, recalling the currency, revaluing the dollar, or anything similar, despite a lot of online chatter about such moves.

A digital dollar would exist alongside the current currency system. People who want to use the digital system to store or transfer dollars would be able to use it directly using the digital dollar instead of the current alternatives involving intermediaries, such as banks.

The Fed’s main reason for considering an official digital dollar is that it’s concerned about digital currencies known as stable dollars. These digital currencies are backed by reserves of actual U.S. dollars. They purport to operate much like a gold exchanged-traded fund that consists of shares that are backed by gold bullion held in storage.

The Fed has several concerns with stable dollars. One is that stable dollars effectively take dollars out of circulation, making it difficult to manage monetary policy.

Also, having dollars tied up in stable coin reserves can make it more difficult for the Fed to act effectively in a liquidity crisis. A good discussion of the pros and cons of the Fed’s analysis is available here.

The Fed isn’t committed yet to establishing a digital dollar. But the paper makes clear it thinks the current stable coin system is undesirable.

What’s likely is that most developed countries will follow China’s example and effectively outlaw or severely restrict digital currencies. They’re also likely to phase in some form of CBDC.

The Data

Retail sales surged in January. After dropping a revised 2.5% in December, sales increased 3.8% in January. After excluding vehicles and gas, retail sales still increased 3.8% for the month.

That’s the largest monthly increase since March 2021. Sales increased 13% over 12 months.

Online sales led the increase, rising by 14.5% for the month. Though the sales increase was broad-based, there were declines in sales for sporting goods and gasoline, as well as at restaurants and bars.

The retail sales report isn’t adjusted for inflation, so the sales number represents increases in both prices and quantity of purchases.

The Consumer Price Index (CPI) rose 0.6% in January and was up 7.5% over 12 months.

Excluding food and energy, the core CPI also increased 0.6% in January and was up 6.0% over 12 months.

The 12-month CPI increase matches levels not experienced since February 1982. The 12-month core CPI increase is at the highest level in almost 40 years. Before the pandemic, the 12-month increase in the CPI was 1.9%.

Price increases are broad-based. As I’ve been anticipating, the home price increases of 2020 and 2021 are slowly making their way into the CPI. Because of the way housing is reflected in the CPI, this should continue to boost the CPI for at least a few more months.

The Producer Price Index (PPI) increased 1.0% in January and 9.7% over 12 months.

The core PPI (excluding food and energy) increased 0.8% in January and 8.3% over 12 months. All those numbers are about twice what economists were expecting.

The 12-month increases for both the headline and core PPI are just below record highs.

Manufacturing activity in New York continues to grow. The Empire State Manufacturing Index was 3.1 in February, an improvement from the negative 0.7 registered in January.

The inflation index in the February report was at a record high going back to the July 2001 inception of the index. In February, 58.6% of companies reported imposing higher prices on sales while only 4.5% reported decreasing their prices.

Industrial Production surged in January, increasing 1.4% from December’s level. In December, production had declined 0.1%.

The headline number is a bit misleading. Manufacturing production increased only 0.2%. Utility production increased 9.9% in January from December’s level. Utility production was unusually low in December because of mild weather across the country.

Industrial production was 4.1% higher than 12 months earlier and 2.1% above the pre-pandemic level of February 2020.

The optimism of home builders hasn’t changed much. The Housing Market Index from the National Association of Home Builders (NAHB) was 82 in February, down a little from 83 in January.

The index hit a high of 90 in November 2020 and has been 80 or above each month except two since September 2020.

The Consumer Sentiment Index from the University of Michigan declined sharpy through mid-February to 61.7 from 67.2 in January.

The mid-February level is the lowest since the fourth quarter of 2011 and was well below average. The index had lower readings during only three other periods: the early 1980s recession, the 2008 financial crisis and in 2011 when there was concern the United States might default on its debt.

The entire February decline was due to changing sentiment in households with incomes of $100,000 or more, according to the director of the survey. Consumers reported being concerned about inflation and having less confidence in government economic policies.

New unemployment claims declined by 16,000 to 223,000 in the latest week. That’s the third consecutive week of declines.

Continuing claims were unchanged at 1.62 million, holding at the lowest level since August 1973.

The Markets

The S&P 500 lost 1.07% for the week ended with Tuesday’s close. The Dow Jones Industrial Average fell 1.22%. The Russell 2000 rose 1.63%. The All-Country World Index (excluding U.S. stocks) added 0.26%. Emerging market equities gained 0.82%.

Long-term treasuries lost 2.31% for the week. Investment-grade bonds fell 1.68%. Treasury Inflation-Protected Securities (TIPS) dropped 0.40%. High-yield bonds declined 1.15%.

On the currency front, the U.S. dollar rose 0.35%.

Energy-based commodities increased 1.49%. Broader-based commodities rose 0.94%. Gold gained 1.44%.

Bob’s News & Updates

My latest book is “Where’s My Money: Secrets to Getting the Most out of Your Social Security.” It tells you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on Amazon.com or Regnery.com.

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