Bob’s Journal for 6/23/22

Behind the Headlines of the Social Security Report

The annual report from the trustees of Social Security was released in early June. The headline of most media stories was that the trust fund was estimated to last a year longer, until 2035, than was estimated last year.

But the details of the report are what really matter. A lot of assumptions are behind the report’s conclusions, and some of those assumptions are debatable.

Consider inflation. Social Security benefits are indexed for inflation. The higher inflation is, the more cash the program has to pay in benefits.

The report estimates that the cost-of-living adjustment (COLA) for 2023 will be only 3.8%. It was 5.9% for 2022, and inflation in 2022 already is higher than that. It is not very realistic that the COLA for 2023 will be only 3.8%, unless one is forecasting a deep recession to begin about now and worsen the rest of the year.

The chief actuary of Social Security already publicly contradicted the forecast, saying that the COLA for 2023 is likely to be around 8%.

The report also assumes the COLA will be 2.5% in 2024 and return to a long-term rate of 2.4% after that. Those are heroic assumptions, depending on a rapid end to the current inflation.

The trustees also continued an assumption that was new last year. The report assumes that the birth rate in the United States increases to 2.0 births per woman, beginning last year.

More births means more workers in the future and more taxes flowing into the system. That would help the system’s solvency.

But the birth rate assumption contradicts both recent experience and forecasts from other sources.

This economist, who used to be an official at Social Security, believes it is more likely the trust fund will be exhausted in 2033.

The Worst Since…

Recently, I realized that I’d been seeing a lot of articles about the economy and markets with headlines that included the phrase: “the worst since…”

So, I did a web search for the phrase “2022 is the worst start for” and received a lot of results.

The articles began in early January, describing how the stock indexes were off to the worst start to a calendar year since the 1930s. Similar headlines continued each month since.

Stocks weren’t the only subject of the articles.

The rise in interest rates was one of the fastest and sharpest in a long time. The jump in residential mortgages rates so far this year is significant.

There actually are more headlines than show up on the web search because subscription websites aren’t covered by the search engines.

For example, Bespoke Investment Group found that through mid-June the classic balanced portfolio of 60% stocks and 40% bonds was down 17.8%. That’s the worst start to a calendar year for that portfolio since 1976.

Part of the reason this year is the worst is that the big stock market declines usually occur in the fall. Only occasionally does the year start with a big decline, and that’s usually a temporary fall that reverses fairly quickly.

But that doesn’t explain all the headlines. The economic and investment news has been bad because the Federal Reserve fell behind the curve on inflation. Now, it must scramble to recover and we’re all going to suffer for it.

Despite this, futures market prices continue to indicate that investors expect the Fed to tame inflation fairly quickly without a lot of damage to the economy.

As you know, I believe that’s not likely. I expect the Fed will have to raise interest rates higher than is priced into the markets and will need to reduce economic growth to contain inflation.

The Fed and Inflation Aren’t the Only Causes of Higher Interest Rates

While most analysts are focused on the Fed’s plans, they also should be looking outside the United States.

For decades, the United States has been able to maintain the value of the dollar despite running big budget deficits. One reason is that foreign central banks and governments have been willing to buy U.S. Treasury bonds.

In particular, Japan and China have been big buyers of treasuries and helped finance our budget deficits.

That could be coming to an end. The latest report of treasury holdings from the Federal Reserve indicated that both China and Japan reduced their holdings in April by selling treasuries, continuing a recent trend.

China’s holdings of U.S. Treasuries are at their lowest level since May 2010. Japan’s holdings of treasuries fell to their lowest level since January 2020.

Overall, foreign holdings of U.S. treasuries declined to their lowest level since April 2021. U.S. Treasuries had their first net foreign outflow since October 2021.

The changes could be temporary. Overseas investors might seek to limit losses because they anticipate the Fed will continue raising rates for a while. Also, the Japanese yen has been falling this year, and sales of treasuries could be related to that.

But it’s also possible that China saw how Russia’s large holdings of U.S. bonds allowed effective sanctions to be imposed earlier this year. China might want to diversify its foreign exchange holdings, and its recent sales of treasuries could be part of a long-term pattern.

Whatever the reason, sales of treasuries by China and Japan caused interest rates to rise well ahead of actions by the Fed. That’s likely to continue for a while.

The Data

Existing home sales declined by another 3.4% in May after declining 2.6% in April. May was the fourth consecutive month sales were lower than the previous month.

Existing home sales in May were 8.6% lower than 12 months earlier, according to the National Association of Realtors (NAR).

Despite lower sales and rising mortgage rates, home prices continued to increase. In May, the median sale price of an existing home increased to $407,600. That was 14.6% higher than 12 months earlier and is a record high since the data began in 1999.

Housing starts declined by 14.4% in May from April’s level. Single-family home starts declined by 9.2% from April to May.

May’s total starts were 3.5% lower than 12 months earlier. Multi-family home starts were unchanged over 12 months and single-family home starts decreased 5.3% over 12 months.

Despite lower starts over the last 12 months, there now are more single-family homes under construction than at any time since early 2006, and multi-family homes under construction are at the highest level since April 1974.

Normally, most of these homes would have been completed, but supply problems are making construction last longer than in the past.

Industrial Production increased only 0.2% in May, following a 1.4% increase in April. The manufacturing component declined by 0.2% in May, after increasing 0.8% in April.

Manufacturing activity contracted in the Philadelphia area, according to the Philadelphia Fed Manufacturing Index for June. The index was reported at negative 3.3, down from a positive 2.6 in May.

New unemployment claims declined by 3,000 to 229,000 in the latest week.

Continuing claims remain near a 50-year low at 1.3 million.

The Leading Economic Indicators index from The Conference Board declined by 0.4% in May, and April’s fall was revised lower to 0.4%.

The Markets

The S&P 500 rose 0.75% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.56%. The Russell 2000 lost 0.73%. The All-Country World Index (excluding U.S. stocks) added 0.49%. Emerging market equities increased 0.17%.

Long-term treasuries gained 1.26% for the week. Investment-grade bonds increased 0.86%. Treasury Inflation-Protected Securities (TIPS) added 0.78%. High-yield bonds rose 0.57%.

In the currency arena, the U.S. dollar declined 1.10%.

Energy-based commodities lost 3.24%. Broader-based commodities fell 2.36%. In contrast, gold rose 1.22%.

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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