Bob’s Journal for 4/7/22

Major Changes in Market Trends in the First Quarter

Most investment markets made sharp turns in the first quarter of 2022.

The new trends began late in 2021, but there were many analysts who believed the changes were temporary. Instead of reversing, the new trends accelerated in early 2022.

The sustained rise in inflation led to most of the other changes. Far from being transitory, price increases were broad-based and brought the major inflation measures to their highest levels in at least 40 years.

The Federal Reserve finally concluded it was wrong throughout 2021 about inflation and growth. The Fed is likely to increase interest rates faster than was anticipated only a couple of months ago and is likely to be more aggressive about shrinking its balance sheet, known as quantitative tightening.

In reaction, stocks had their worst quarter in two years.

The S&P 500 lost 4.9% for the quarter, following seven consecutive quarters of positive returns. The Dow Jones Industrial Average declined 4.6%, and the Nasdaq Composite fell 9.1%. That’s the highest margin of outperformance by the S&P 500 over the Nasdaq since 2006.

During the quarter, markets were extremely volatile. At one point, the Nasdaq reached the traditional measure of a bear market with a decline exceeding 20%. But it recovered enough to finish the quarter with less than a 10% loss.

Bonds also fared poorly.

The most widely followed bond index, the Bloomberg U.S. Aggregate, lost more than 6%. That’s the index’s biggest quarterly loss since 1980.

The yield on the two-year treasury had its largest one-quarter increase since 1984, and the five-year treasury yield increased the most in a quarter since 1987.

Mortgage interest rates climbed to their highest levels since 2018 and are close to exceeding 5% for the first time in four years.

Commodities, on the other hand, had a great quarter. Energy led the way, with oil topping $130 a barrel at one point. Many other commodities also had double-digit-percentage returns. Energy stocks were the best-performing sector in the S&P 500 by a wide margin.

Despite the significant change in market direction, investors still seem complacent.

The futures markets continue to indicate that most investors believe inflation will be contained after a modest increase in interest rates and that economic growth won’t be hurt much by the tightening.

Most investors are underestimating how much the Fed has to tighten monetary policy to wring inflation out of the system and how much that is likely to reduce economic growth.

In anticipation of the tightening to come, our Retirement Watch portfolios have significant allocations to inflation hedges and value stocks and little or no exposure to growth stocks and traditional fixed-income investments.

SECURE Act 2.0 Begins to Sail Through Congress

The latest attempt to increase retirement savings moved quickly through the House of Representatives on March 29.

The Securing a Strong Retirement Act of 2022 (SECURE Act 2.0) made it through the House by a 414-5 vote. The law is a collection of bills have been introduced since the original SECURE Act was enacted in late 2019.

Key provisions of the law would expand automatic enrollment in employer retirement plans, increase and modify the credit small employers receive for creating retirement plans and simplify the Saver’s Credit individuals can receive for retirement plan contributions.

The SECURE Act 2.0 also would increase the IRA catch-up contribution limit for those ages 50 and over by indexing it to inflation. For 401(k)s and other employer plans, the limit for catch-up contributions would be increased for those ages 62, 63 and 64.

The beginning age for required minimum distributions (RMDs) would increase from the current 72 to 73 in 2023, 74 in 2030 and 75 in 2033.

I’ve said before that I consider raising the RMD age to be a tax trap. It encourages people to leave money in a traditional IRA or 401(k) so that it accumulates to a higher level. When the money finally is distributed, that increases lifetime income taxes or income taxes on heirs.

People who can afford to leave money in their traditional retirement accounts should consider strategies that reduce future RMDs, such as converting all or part of the traditional IRA to a Roth IRA or repositioning the traditional IRA as permanent life insurance, a charitable remainder trust, or a taxable investment account.

The penalty for failing to take a required minimum distribution would be reduced from the current 50% of the amount that wasn’t distributed to 25%. But the penalty would be 10% if the RMD is taken in a timely manner after the mistake is discovered.

These and the many other benefits in the Act will reduce tax revenue, so they must be offset by revenue increases.

The SECURE Act 2.0 would raise revenue by increasing the “Rothification” of retirement plans.

Under the bill, SIMPLE and SEP IRAs would be allowed to have Roth versions, which aren’t allowed under current law.

In addition, all catch-up contributions to employer plans would be treated as Roth contributions after 2022. That means there would be no upfront tax benefits to catch-up contributions. The employee would have to include the catch-up contribution amount in gross income and pay taxes on it.

In addition, matching contributions to an employer retirement plan such as a 401(k) could be treated as Roth contributions at the option of the employee.

The bill now is in the Senate where it is expected to be passed fairly quickly and without changes.

The Backdoor Roth IRA is Back

The SECURE Act 2.0 and the President’s latest tax proposals don’t include the prohibition of backdoor Roth IRAs that was prominent in 2021 proposals. That means it is safe to plan for a backdoor Roth IRA in 2022 and probably beyond.

A backdoor Roth IRA is when an employee makes after-tax contributions to a traditional 401(k). Subsequently, the after-tax contributions are rolled over tax free to a Roth IRA. See the November 2019 issue of Retirement Watch for details.

The strategy is valuable to higher-income employees, because their income levels prohibit them from making regular Roth IRA contributions. The backdoor Roth IRA strategy let’s them establish tax diversification by having some money in a Roth IRA.

The backdoor Roth IRA also allows higher annual contributions than regular Roth IRA contributions.

The Data

There were 431,000 new jobs created in March, and February’s total was revised higher to 750,000 from 678,000, according to last Friday’s Employment Situation reports.

New jobs exceeded 400,000 for 11 consecutive months, the longest streak on record going back to 1939. The unemployment rate declined to 3.8%, just above the 50-year low of 3.5% recorded in February 2020.

The data also revealed an increase in the labor force. The labor force participation rate increased to 62.4% in March, up from the low of 60.2% in April 2020.

The male labor force participation rate is back to pre-pandemic levels. More than 300,000 women entered the labor force in March, but there still are fewer women in the labor force than before the pandemic.

The share of retirees re-entering the labor force increased to its highest level since March 2020.

Overall, the economy still has 1.6 million fewer workers on payrolls than in February 2020.

Average hourly earnings increased by 0.4% in March, bringing the 12-month increase to 5.6%.

New unemployment claims increased by 14,000 from the previous week’s 52-year low to 202,000 in the latest week.

Continuing claims decreased to about 1.3 million.

The Chicago PMI increased to 62.9 in March from 56.3 in February.

Personal income increased 0.5% in February and 6% over 12 months.

Personal consumption expenditures (PCE) increased 0.2% in February from January’s level, and PCE was 6.4% higher than 12 months earlier.

But consumers are feeling the effects of inflation. Real PCE (PCE after adjusting for inflation) decreased 0.4% in February. Income after inflation and taxes declined for the seventh consecutive month to the lowest level since March 2020.

The Fed’s preferred measure of inflation, the PCE Price Index, increased 0.6% in February and 6.4% over 12 months. That’s a new 40-year high.

The PCE Price Index, after excluding food and energy, increased 0.4% in February and 5.4% over 12 months.

The ISM Services Index increased to 58.3 in March from 56.5 in February.

The ISM Manufacturing Index declined to 57.1 in March from 58.6 in February.

But the PMI Manufacturing Index increased to 58.8 in March from 58.5 in February.

The PMI Services Index declined to 58.0 in March from 58.9 in February.

The PMI Composite Index declined to 57.7 in March from 58.5 in February.

Factory Orders declined 0.5% in February after rising 1.5% in January.

Much of the decline was due to reduced production in transportation, and much of that decline was due to supply problems. Orders for core capital goods, a good measure of business investment, declined only 0.2%.

The Markets

The S&P 500 lost 2.28% for the week ended with Tuesday’s close. The Dow Jones Industrial Average fell 1.88%. The Russell 2000 declined 4.12%. The All-Country World Index (excluding U.S. stocks) dropped 1.52%. Emerging market equities decreased 0.26%.

Long-term treasuries lost 1.57% for the week. Investment-grade bonds declined 1.08%. Treasury Inflation-Protected Securities (TIPS) fell 1.17%. High-yield bonds dropped 1.22%.

The dollar rose 1.03%.

Energy-based commodities fell 1.21%. Broader-based commodities rose 1.36%. Gold declined 0.03%.

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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