Bob’s Journal for 3/24/23

Some Notable Events That Grabbed My Attention This Week

Correction: In the April 2023 issue of Retirement Watch (which was published electronically last week and will be in the mail shortly), the ticker for iShares Global Metals & Mining Producers on page 11 was misidentified and should be PICK, which is stated correctly in the tables of recommended portfolios. In the issue, I recommend selling PICK.

The Economy and the New Bank Failures

The laws and regulations that followed the financial crisis of 2007-2009 didn’t fix the banking system.

The system still is vulnerable, but in different ways than before. Under the old regime, banks were prone to using too much leverage and taking on too much credit risk.

This time, the banks in trouble received most of their funds through short-term deposits and invested those deposits in long-term assets that are safe over the long term, such as long-term treasury bonds. But once the Federal Reserve hiked interest rates, the long-term assets lost value. When depositors moved their money out of some banks, those financial institutions needed to sell assets at losses.

They needed to make up those losses to have adequate reserves. Once word was out that the banks needed additional capital, more depositors began pulling their assets and bank runs began.

Currently, it appears the banking troubles won’t be as widespread as during the financial crisis. But it’s hard to know, since bank runs are fueled by perception and emotion.

But the banking problems probably will reduce economic growth. Many banks will lend less than they would have, because they’re concerned about having enough liquid assets to satisfy any depositor withdrawals.

Also, because rising interest rates reduced the values of their reserves, the banks have less money to lend.

In short, credit is likely to be less available to both businesses and individuals. That, coupled with the sharp rise in interest rates over the last year, should slowly reduce growth and eventually cause a recession.

The Fed is the wild card. It could decide the banking system is so vulnerable that the tightening policy needs to be paused or reversed. I don’t think that’s likely as long as inflation is well above target, but it’s possible.

Because there are a range of possible outcomes, it’s important to remain diversified and, unlike some banks, have a margin of safety in each of your investments.

We Mark Three Years of Volatility, Turmoil

It was only three years ago this month that government officials decided they needed to close most of the economy in response to the spread of the COVID-19 virus.

That was one of a series of related decisions with long-lasting effects.

To prevent a deflationary depression, Congress accompanied the shutdowns with very large fiscal stimulus. The Fed supplemented that stimulus with an expansionary monetary policy. The Fed essentially decided it would buy all the bonds the U.S. Treasury issued to pay for the deficit spending.

Households and businesses were flooded with money that was transmitted directly into the economy and markets.

Parts of the economy boomed. Consumers shifted to buying more goods and fewer services. A lot of economic activity moved online, and that caused an explosion in demand for web-based services and equipment.

But once the stimulus ended and the economy began to re-open, many pandemic trends reversed. Buying shifted toward its pre-pandemic mix of more services and fewer goods. Many goods-providing businesses that expanded to meet the higher demand now have excess capacity.

Tech businesses also expanded too much. We’ve seen a lot of lay offs by large tech companies because they no longer see the high and growing demand for their services that was projected only a year ago.

Perhaps the most significant effect is the resurgence of inflation. A few years ago, central bankers were complaining that they couldn’t push inflation to their 2% target and the economy was always on the edge of deflation. That allowed the central bankers to set policy without having to worry about inflationary effects.

But the stimulus policies of the pandemic period more than offset the deflationary factors.

In 2022, inflation surged to its highest levels in 40 years. Even after the most rapid tightening of monetary policy in at least that long, inflation remains well above the Fed’s target and appears to be sticky at current levels.

The result is the Fed now has to fight two problems with contradictory solutions.

A banking crisis usually is resolved by injecting liquidity into the economy. But inflation is resolved by withdrawing liquidity from the economy. Because of actions that began three years ago, the Fed faces the difficulty of deciding how to balance its policies to contain inflation without worsening the banking crisis or triggering a deep recession.

Don’t Take Tax Advice from Artificial Intelligence

The latest artificial intelligence technology can do a lot of interesting things. But it apparently can’t provide good tax advice.

AI can answer many questions and write essays, poems and more. It apparently has done well on several types of examinations. But it fails when asked to help with tax questions, according to an article in Bloomberg Tax.

The first problem is that ChatGPT, the technology used in the test, only has information through 2021. So, some of its tax information is out of date.

Also, the tax code often doesn’t have the clear-cut answers the technology needs. There are a lot of gray areas in the tax code or areas that require some human judgment and balancing.

The firm TaxBuzz said it created some realistic scenarios and asked ChatGPT to provide the correct tax advice for each. TaxBuzz said the technology was wrong 100% of the time. It often was on the right track but missed some key points.

The Data

Existing home sales increased 14.5% in February after declining 0.7% in January. That’s the largest monthly increase since January 2020 and ends a 12-month streak of declines.

The median existing home sale price declined by 0.2% from 12 months earlier to $363,000. That’s the first 12-month price decline in the median existing home sale price in 11 years. The median price is 12.3% lower than the record high reached last June.

Housing starts increased by 9.8% in February after declining 2.0% in January. That’s the first increase in six months.

Building permits also surged, increasing 13.8% in February after climbing 0.1% in January.

The Philadelphia Fed Manufacturing Index improved a little to negative 23.2 in March from negative 24.3 in February.

Industrial production was unchanged in February after increasing 0.3% in January. Over 12 months, production is down 0.2%, the first 12-month decline since February 2021.

Manufacturing production increased 0.1% in February and was down 1.0% over 12 months.

The Consumer Sentiment Index from the University of Michigan fell to 63.4 in March from 67 in February.

Assessments of both current conditions and expectations declined. Inflationary expectations for the next 12 months were at a two-year low but remain well above the Fed’s 2% target rate.

New unemployment claims declined by 20,000 to 192,000 in the latest week. It was the biggest one-week decline since July.

Continuing claims, which lag a week behind new claims, decreased to 1.684 million from 1.713 million.

The Markets

The S&P 500 surged 2.23% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 1.34%. The Russell 2000 increased 0.07%. The All-Country World Index (excluding U.S. stocks) added 0.23%. Emerging market equities rose 0.45%.

Long-term treasuries gained 0.87% for the week. Investment-grade bonds increased 1.50%. Treasury Inflation-Protected Securities (TIPS) added 0.17%. High-yield bonds gained 0.54%.

On the currency front, the U.S. dollar declined 0.21%.

Energy-based commodities lost 1.79%. Broader-based commodities fell 1.55%. Gold rose 2.02%.

Bob’s News & Updates

My latest book is “Retirement Watch: The Essential Guide to Retiring in the 2020s.” Learn more and order by clicking here and here. You can be among the first to write a review.

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