IronBridge Private Wealth

Forward with Confidence

7 Lessons for Any Bear Market

Vienna, Austria - May 20, 2017: Main hall of the historical Austrian National Library in Vienna (Austria) on may 20, 2017, with an ancient globe map

That is the great fallacy: the wisdom of old men. They do not grow wise. They grow careful.

Ernest hemingway, “A farewell to arms”

Bear markets are not fun.

We all know that.

But there are valuable lessons from bear markets if you learn them.

Fortunately (or maybe unfortunately), we’ve lived through quite a few over the past 25 years. And given the volatility experienced during that period of time, our investment “age” would place us as old men. (The women of IronBridge remain obviously youthful.)

So Hemingway’s line from “A Farewell to Arms” resonates with us.

Bear markets may or may not create wisdom, because each one is different.

We don’t know how this one will play out. No one does.

But we have learned to be careful.

This got us thinking about various lessons we can learn from previous bear markets, and how we can apply them to today.

Below, we look at some higher-level lessons that relate to you and your well-being, as well as those learned from financial markets directly.

Let’s dig in.

Lesson #1: Keep Your Financial Plan on Track

The worst possible outcome of market volatility is not a decline in your wealth…it is a decline in your LIFESTYLE.

Don’t let that happen.

A good financial plan will factor in volatility in your portfolio. It is called stress-testing, and it is a statistical analysis using variable portfolio returns.

The chart below shows an example of hypothetical return projections for an actual client’s financial plan.

Real life future return projection including variability in returns and statistical analysis of a financial plan.
Source: IronBridge

This is just one of a thousand different potential scenarios our planning software uses to stress test someone’s probability of success in a financial plan. (Please do not hesitate to reach out if you would like us to update your individual financial plan.)

Two major things we notice about this projection:

  1. Returns are not linear. Our software does not assume the same return every year.
  2. Returns aren’t always good. Four of the first five years in the chart show negative returns. The worst projected decline is negative 28%.

Assuming variability makes your plan more realistic.

By projecting that bad years will happen, your portfolio can better weather the storms when they happen.

Lesson #2: Avoiding Large Declines is Key

This seems like the most obvious lesson, but avoiding large declines is the SINGLE MOST IMPORTANT thing you can do when investing.

Why?

Because when you experience large declines (which we define as 25-30% or greater), you don’t only sacrifice your financial plan, you lose the most valuable investing commodity there is: time.

You lose time by requiring huge gains to get back to where you were before the bear market began.

The next chart shows the return needed to get back to breakeven for various portfolio declines.

Returns needed to recover after various portfolio declines on a percentage basis.
Source: IronBridge

This chart shows that if your portfolio is down 10%, you need an 11% return to breakeven.

What stands out to us is that if your portfolio declines 30%, you need a whopping 43% return to breakeven. This is a huge return that takes multiple years to accomplish.

If you have a 40% or 50% decline, you need incredible future returns to get back to where you were.

These types of declines are not only painful emotionally, but will have hugely negative effects your long-term financial health.

Having the ability to move to cash is critical in our opinion.

Cash and short-term fixed income are the only predictable places to hide when major volatility hits the market.

Lesson #3: Diversification is Not Risk Management

Having different assets in your portfolio does not mean your portfolio is protected against large declines.

This year is a perfect example.

As of today, long-term bond prices have fallen MORE than stocks on a year-to-date basis, as shown in the chart below.

Stocks and bonds all down so far in 2022.

Maybe this changes in the second half of the year.

But relying solely on diversification as your primary risk management tool is not a good strategy to avoid large declines.

Lesson #4: Prices can Fall Further than You Think

There’s an old saying in the markets:

“How does a stock fall 90%? Easy, first it falls 80% then it gets cut in half.”

The lesson is that prices can be extremely volatile in bear markets, and can fall well beyond what may seem logically possible.

Let’s look at an extreme example of this today: Zoom stock.

Zoom was a darling of the COVID period as people abandoned the office and went remote. We at IronBridge became Zoom clients, and still use it many times per day.

Their earnings have consistently increased over the past two years, as shown on the bottom half of the chart below. The top half is price (blue line), and the orange is earnings per share.

Zoom stock has fallen 86% despite earnings increasing substantially.

Not only have earnings increased, but they have massively increased (up more than 8-fold).

Over the same period of time, however, the stock has been crushed.

It was down 86% from peak-to-trough. Ouch.

This illustrates perfectly that the market is not always logical. We would go a step further and say that more times than not it is very illogical.

But if you are prepared for it, both strategically and emotionally, you can handle the fact that it will probably do things that don’t make sense.

Lesson #5: Markets Lead, Economic Data Lags

One of the most common arguments during the early stages of a bear market is that the economic backdrop is strong.

The problem is that economic data is backward-looking.

In 2008, the initial GDP numbers were positive for most of the year. It was only until late 2008 (when the market was down nearly 40% on its way to being down over 55%), that GDP was revised lower for previous quarters.

It showed that the actual recession started nearly 12 months before, in late 2007. But in real time, GDP didn’t go negative until the market already declined.

Don’t rely on forecasters to give you any help, either.

Here are forecasts from the 12 largest investment firms in 2008. This was published in Barron’s magazine in early 2008 after the market had already peaked and was down nearly 20%.

Just over a year later, the S&P 500 bottomed at 666 (this still freaks us out a bit). Most of these forecasts were wrong by over 1,000 points. Nice work.

Instead of looking at the economic data itself, like the fine prognosticators above were, pay attention more to the trends of the data:

  • Is economic data improving or deteriorating?
  • Are companies lowering forward guidance, or do they foresee continued strength?
  • What are leading economic indicators doing?
  • Is previously reported economic data being adjusted higher or lower?

Markets will price in risk before the economic data reflects the risk.

Sometimes the markets are wrong. After all, not every bear market results in a recession.

But if you can identify how economic data is trending, you can better assess the overall risk in the market.

Lesson #6: Bear Markets Don’t Repeat, but They Tend to Rhyme

No bear market is exactly like a previous one.

But there are similarities.

For one, there tends to be excess speculation somewhere in the economy or markets.

In 2008, it was real estate. In 2000, it was tech companies. Today, central banks have printed our way into a complete mess. In addition, crypto is one area where we are seeing excess speculation turn into massive losses in value.

In addition to working off excesses, bear market patterns tend to look similar.

The first chart below compares 2008 to 2022.

Current market looks similar to 2008.

Looks pretty similar to us.

In 2008, there was a 22.5% drop before the bottom fell out of the market. Today, markets are down 23.5%. Maybe this suggests we are close to a similar outcome.

But there are plenty of chart comparisons that don’t result in massive declines.

In 1984, there was a recession, and the Fed was fighting inflation.

The next chart compares 1984 to today.

Current market looks similar to 1984

The pattern here looks pretty similar as well.

While both comparisons pass the eye test, each environment was different than today.

So while looking at these types of charts are interesting, they shouldn’t drive your behavior one way or another.

Lesson #7: Bear Markets can Happen in either Price or Time

When most of us think about a bear market, we naturally think of 2000 or 2008.

These were bear markets in PRICE.

In 2000, the Nasdaq fell over 70%. In 2008, the S&P 500 fell more than 55%.

Those of us in the markets then will remember those periods for the rest of our lives.

At their core, bear markets work off excesses of the previous economic and market expansion.

Prior to both 2000 and 2008, markets grew at rates that were were unsustainable. By the time these bear markets were done, prices collapsed and all the excesses were removed.

Price corrections tend to happen over the course of 1-3 years.

But markets can correct in TIME as well.

We haven’t seen a correction in time in quite a while.

In fact, the 1970’s were the last real sideways bear market.

The final chart looks at the Dow Jones index back to the late 1800’s.

Long term chart of the Dow Jones shows longer term bear markets.

This chart shows 5 major periods of sharp price declines: 1929, 1987, 2000, 2008 and 2020 (circled in red above).

The tamest of these periods was 1987, when the market “only” lost 34%. Each other time, markets fell well in excess of 40-50%.

Additionally, there were 3 major bear markets that occurred in “time” (the blue shaded areas above):

  • 1900-1915
  • 1934-1950
  • 1968-1982

Each of these periods lasted either 15 or 16 years. That’s a long time to have to wait for returns to start moving higher again.

Fortunately, these major bear markets don’t happen all that often.

But one thing in common with the previous bear markets that corrected in “time”: rising interest rates.

If we are going into a period of rising rates, which seems like a good assumption, the likelihood of a bear market in time seems to be a higher likelihood than a bear market in price.

Don’t let that scare you, though…there are ways to make money in a choppy sideways market.

It requires two components:

  1. Tactical exposure in the markets.  You don’t want to buy-and-hold in a “time” bear market.  The volatility will chew you up and spit you out.  You must have the ability to move to cash to limit volatility when downturns happen, but be able to increase exposure to areas performing well.  This is the basis of our investment philosophy at IronBridge.
  2. Increase exposure to yield-generating assets as interest rates rise.  As yields go up, you can earn more on a variety of assets to compliment your tactical market exposure.

We are preparing for this exact scenario, and have already begun having discussions with a number of our clients about what this means in your particular situation.

Bottom Line

In summary, there are always lessons to learn from any market environment.

But it does appear that we are in a bear market that may not reverse as quickly as those that have occurred since 2008.

Thus, us battered old investment men at IronBridge will echo Hemingway’s quote and be careful and cautious until the situation tells us not to be.

Invest wisely!

Gimme Shelter

A Directional Sign in Front of Storm Clouds indicating the Storm Evacuation Route. Arrow on sign is directing to the right.

Ooh, see the fire is sweepin’
Our streets today
Burns like a red coal carpet
Mad bull lost its way

– Rolling Stones, “Gimme Shelter”

The mad bull has lost its way.

And an historically volatile year is getting worse.

Last week it appeared that the market may have saved itself from more volatility.

But out-of-control inflation numbers once again show that this environment is anywhere from over.

In fact, it’s getting worse.

We don’t say this lightly, but the risk of a major market melt-down is extremely high right now.

The way the market structure looks right now is concerning.

Here are four of our major concerns:

  1. The Fed wants to reduce inflation, despite the consequences to the market or the economy.
  2. The bond market is cratering.
  3. Positioning in the market still remains bullish, despite very bearish sentiment.
  4. Patterns within the market are mirroring previous major declines.

We’ll briefly discuss each of the above, but let’s talk about portfolio positioning first.

Portfolio Update

Two weeks ago, the market rallied, and caused us to add measured equity exposure to portfolios.

As of today, all of that increase has been reversed, and equity exposure is now lower than it was three weeks ago.

Overall, we are extremely underweight exposure to stocks. And we expect that to be reduced throughout the week as well.

The next chart shows how your equity exposure looks relative to the maximum amount of equity you could potentially have in your portfolio.

The remaining balance is in cash and short-term fixed income.

NOTE: When we say “cash”, we are referring to cash and cash equivalent ETFs in your account. The following tickers are considered either cash equivalents or short-term fixed income, with very little volatility: FTSM, BIL, GSY, RAVI, SHV and PSDYX.

By the end of this week, it may make sense to use inverse ETFs to hedge equity exposure for a short period of time, while holding certain positions that are still showing favorable risk/reward metrics. (We did this during the COVID crash in March of 2020, and it proved to be a very effective risk management tool.)

So while we have already reduced your equity exposure dramatically, it could get even lower as the week goes on.

As always, please reach out to us directly with any questions.

The Fed

The Fed meets this Wednesday.

They are in a bind.

Earlier today, the market was projecting a 72% probability of a 0.50% rate hike, with a 28% probability of a 0.75% hike.

However, after the market, the Fed apparently leaked data suggesting they would do a 0.75% hike instead.

Probabilities immediately rose, and the market is now projecting a 93% chance of a 0.75% hike on Wednesday. All in the matter of a couple hours.

The next chart shows the probability earlier today, courtesy of the CME group. Click on the chart to be taken to their website. The bar on the left is the probability of a 50 bps rate hike, and the one on the right is for 75 bps.

And here are the probabilities now…

Just over a week ago, the probability of a 0.75% rate hike was only 3%. So in a few short days, the Fed changed their mind.

They have a fundamental choice to make: do they crash the markets and economy and reduce inflation, or do they blink and let inflation get further out of control?

It seems pretty clear which approach they want to take: fight inflation and the markets be damned.

Frankly, they are sleeping in the bed they made.

They let the bull market get crazy, and now the mad bull has lost its way.

The Bond Market

Bonds typically are a hiding place during volatility.

But when the Fed is raising rates, bonds have had more volatility than stocks.

In fact, long-term US treasury bonds are down over 58% over the past two years, as shows in the next chart.

This is not a sign of a healthy environment.

Positioning versus Sentiment

One of the things we’ve been watching as a positive for asset prices is sentiment.

Sentiment is a contrary indicator.

When sentiment is extremely positive, market prices can be near a top.

Conversely, when sentiment is extremely negative, like it is now, it can be a sign that a low in prices are near.

However, new data has come out showing positioning by investors.

And what is shows is that what people are saying versus what they are doing is very different.

The next chart, courtesy of All-Star Charts, shows this variance.

The orange line is positioning. This shows the current allocation to stocks by a survey from the AAII (American Association of Individual Investors).

The blue line is sentiment. It shows the University of Michigan Consumer Sentiment readings.

Previously, there has been a very strong correlation between the two.

Now, this correlation has broken down completely.

This suggests one of two things:

  1. Consumers are overly pessimistic, and will ride out this storm.
  2. Investors are overly allocated to stocks, and a massive shift out of equities is about to occur.

Our guess is that the second scenario is the likely outcome.

Market Patterns are Similar to Previous Major Bear Markets

First of all, every decline is unique. We do not use this type of analysis in our day-to-day investment management process.

But it is interesting just how closely the current market environment resembles major bear markets from the past.

The final chart, from Nautilus research, shows how the current environment compares to other major bear markets in 1937, 1973, 2000 and 2008.

(Our apologies for the small print…click to view a larger version.)

The correlation of the current market to each of these previous bears is very high.

In fact, the current market has over a 90% correlation with each of these environments.

Again, we don’t have any direct inputs based on analysis like this, but it does suggest that the overall pattern is similar to other major tops. And we should be aware of these types of correlations.

Bottom Line

We were hoping the volatility was over, and that the extremes in sentiment that we have seen recently were going to be good signs of an impending low.

However, our concerns now are “how much further can this fall”?

We wish we knew.

The bottom could have happened today. We doubt it, but it could have.

However, the bottom may very well be much, much lower from here.

And we’re not going to wait around to see what happens. We’re not going to HOPE things change. We’re not going to stand by and let an out-of-control market destroy your hard-earned capital.

We are going to ACT. We have already taken major steps to reduce risk, and are prepared to take even more as warranted.

We’re in a time of MAJOR risk for markets.

Today felt a little panicky. Our guess is that it starts to feel much more panicky in the coming weeks and months.

If we are wrong, we will gladly admit it and add equity exposure back into your portfolio.

But if we are right, we will help you avoid what is potentially one of the largest bear markets in history.

When the mad bull finds its way again, we’ll be prepared.

But in the meantime, we’d rather protect your portfolio than stand by and watch it fall.

Invest wisely!

Stick Save

A stick save occurs in ice hockey when a player uses his stick at the last second before the puck enters the goal.

We realize that an ice hockey reference may be considered blasphemous. We’re in Texas, after all.

But a stick save is an excellent reference for what happened this week.

Just when it looked like the bottom was about to fall out of the market, prices reversed higher.

In our recent webinar, we discussed scenarios where the market moved higher to test 4100, and the real information would be gathered if/when that happened.

(Here’s our webinar in case you missed it…our scenario discussions begin at minute 13:31)

Right now, most of the economic data is heavily skewed to suggesting more downside in prices, mainly due to persistently high inflation and a slowing economy.

As we mentioned in our webinar, the one thing that could support the market here is sentiment.

And it looks like sentiment is coming to the rescue.

When we say “sentiment”, we are referring to two things:

  1. Investor optimism and pessimism
  2. The positioning within the market

The first item above is simply a gauge of investor attitudes. It can give good information about the overall environment, but it doesn’t have any direct impact on stock prices.

The second item does.

“Positioning” within the market refers to the actions being taken by market participants.

This is essentially the “plumbing” of the market.

When more money flows in one direction, prices follow. Just like water in a pipe.

If more money is buying, prices go up. And vice-versa.

This may sound simple, but this plumbing refers to how markets actually work. It doesn’t matter what the P/E ratio is, or what GDP is doing, or what interest rates are.

GDP may cause more investors to buy or sell, but GDP is not a direct input to stock prices. It is an indirect input.

What matters is flow.

The volume of money moving throughout the market is the only direct input that matters.

Despite the legitimate worries about inflation, the economy, geopolitics, etc. (indirect inputs), enough people acted on it before last week (by selling stocks) that prices moved lower (direct inputs).

It looks like sellers were finally exhausted last week, so buyers were able to push prices higher in the face of deteriorating economic data.

Which puts the market right into the middle of an important resistance zone, as we also identified as a possibility in our webinar.

The next chart shows the S&P 500 this year.

S&P 500 Index at critical resistance. If it breaks higher, markets could rally 10% or more. If it stays below current levels, the bear market could continue. Next week is very important.

A couple weeks ago, the critical 4100 level broke to the downside. However, markets staged a rally and are now testing the resistance area.

It’s akin to a hockey player swiping away a puck right as it is entering the goal.

Stick save.

This rally makes the next two weeks critically important.

Markets were closed on Monday is observance of Memorial Day, but the shortened week should be one of the most important weeks of the year. It may end up carrying into next week, but the market should tip its hand soon.

If it can break higher from here, chances increase that we may have seen the low point for this bear market.

We are definitely not out of the woods if the market breaks higher, but it does start to suggest that the majority of the bad news has indeed been priced in.

However, if we see a selloff this week, then we need to be prepared for another major leg down.

The initial target for the S&P 500 Index on a move lower would be 3400, with another support level at 3100. (The S&P 500 is just over 4100 currently.)

So we can’t be blindly bullish here, but we can’t assume that things are all negative either.

If the market does keep rising, we will begin adding stock exposure back in client portfolios, and take on more of a cautiously optimistic tone.

We’ll provide another report late this week or sometime next week to provide an update.

Invest wisely!

Wise Men and Fools

The fool doth think he is wise, but the wise man knows himself to be a fool.

“As you like it”, Act v scene i, by william shakespeare

Markets are never easy.

Granted, there are times when things seem easier than others.

Over the past 13 years, investors have grown increasingly complacent about how easy investing can be. After all, every time there was a blip in the market, prices came roaring back quickly.

When data and trends align well, we can make higher probability conclusions about the direction of the market.

But when we have conflicting data, as we have now, it becomes more difficult to identify the direction with any real confidence.

Shakespeare’s quote is appropriate for this environment.

To think we know for sure what will happen is foolish. It is much better to acknowledge that we don’t know what will happen, so we can view developments with objectivity.

There are strong reasons to be optimistic about the markets over the coming months and years.

However, there are strong reasons to be incredibly pessimistic about the markets as well.

An important skill in this type of environment is to be mentally flexible. To know that you don’t know what will happen.

Let’s look at both the positive and negative data in the economy and markets right now to get a better understanding of the investing environment.

Bullish vs Bearish Data

First, let’s take a high-level look at the bearish and bullish arguments.

On one hand, we have plenty of reasons to be concerned:

  • The Fed is tightening
  • Inflation is extremely high
  • Ukraine War continues to be drawn out
  • Supply chain issues and food shortages globally are concerning
  • Valuations in many areas (stocks and real estate specifically) are still very high

We just need some turmoil in the Kardashian family and we have a cable news executive’s dream.

On the other hand, not everything is bad:

  • The US economy is strong
  • Corporate earnings and balance sheets are solid
  • Liquidity is still readily available
  • The US consumer is strong, on the back of high real estate valuations and increased incomes
  • Investor sentiment is very pessimistic (this is a contrarian indicator where this much pessimism tends to happen at market lows)
  • Some areas of the market have fallen 50-70% in value from last year, so some of the froth has been removed from various areas of the market.

Here’s an overview.

Bullish versus bearish data in the economy and the stock market.

Let’s look at two paths: one to lower stock prices, and another to higher ones.

The Path to Lower Stock Prices

Looking at the issues above, the biggest one by far is the Fed.

Yes, the war in Ukraine continues to be drawn out. Yes, inflation is very high. Yes, supply chain issues continue to be a problem.

Recession risks have increased in the past few months as well. Goldman Sachs currently places a 35% likelihood of a recession this year.

But the Fed has been the 10,000-lb gorilla in the room for a decade.

And their policy of massive monetary stimulus has now officially ended. They are no longer printing money, and they have started to raise interest rates.

This is not a small change.

We would argue that the Fed is the single most-important reason the market has been so incredibly strong over the past decade.

A reversion of policy should have an impact.

Their belief is that the US economy is strong enough to not depend on their artificial liquidity as support. Maybe they are right. After all, the economy is pretty strong.

The main problem is that the inflation cat has left the proverbial bag.

And it’s still too early to know how much of a negative affect it will have on the economy.

In all reality, it will take a number of months before inflation has a notable impact on economic data.

But the longer that inflation stays high, the more we will start to see reduced demand for a variety of goods.

For those with an economic background, it’s called “elasticity” of demand. Consumers are only willing to pay for something up to a certain price.

When the price gets too high, consumers stop buying it. We haven’t seen this just yet, but it’s hard to imagine we’re too far away from it.

Here is the pickle the Fed finds itself in: reduced demand will help lower inflation, but it will also cause a recession.

Not only is inflation rising, but so are interest rates. The combination of these two could wreak havoc on both the economy and financial markets.

But in an inflationary environment, not everything falls in price. There are many areas right now that are pushing to new highs, despite stock prices being lower.

The Nasdaq Composite index (mainly comprised of tech stocks) is now down over 20% from its highs. But consumer staples stocks pushed to new all-time highs last week.

While the broad market may not be very good right now, there are underlying pockets of strength.

These pockets of strength could be an indication that stock prices overall may resume their push higher soon. So let’s look at reasons we might need to be optimistic about the overall market environment going forward.

The Path to Higher Stock Prices

Yes, the Fed, inflation and interest rates are headwinds. But not everything is bad.

Earnings season picks up this week, and we should get more clarity on how companies are weathering the inflationary and uncertain geopolitical environment. So far, earnings have been good. Most estimates call for an increase in earnings of 4.5% year-over-year. Not great, but not bad either.

Just because we assume data should be negative doesn’t mean it will be.

One way that negative data isn’t quite showing up in the real economy has to do with mortgage rates.

The average 30-year mortgage is now above 5% for the first time in 11 years. But it hasn’t had a negative affect on homebuilders and home buyers just yet.

The next chart shows housing starts and building permits, one of the leading indicators of the housing market.

US housing starts and new building permits suggest that mortgage rates are not having much effect on the housing market yet.

In this chart, the blue lines are housing starts and the green lines are new building permits. In the past few months, they have been steady. New housing starts have actually risen a bit.

This could be a last minute push of people trying to build homes before rates get too high. But if nothing else, it tells us that mortgage rates may not be high enough to cause a housing slowdown. Time will tell.

With home-buying season about to start, we should know a lot more about the health of the housing market in the next few months.

This points to a consumer who has had both asset values and incomes rise.

And the consumer accounts for 68% of the US economy.

We should not ignore the positive impact that an optimistic US consumer can have on the economy and stock prices.

S&P 500 Index Levels

Let’s now look at the market itself.

Here’s an updated view of the S&P 500 Index, with the important levels to watch right now.

S&P 500 Index levels to watch for bull or bear market. Bullish above 4600, bearish below 4100. Chop zone in between.

We’ve broadened out our chop zone from a month ago, as the market seems to be stuck in a range between 4100-4600. (We had previously identified the chop zone as a range between 4100-4400.)

The real risk now is a break below 4100, or the lower end of the red area in the chart above.

There is very little support below this level, and we could easily see a scenario where markets fall another 10-20% if 4100 does not hold.

If it does fail, we will aggressively raise cash further.

Until that time, however, we should not assume that it will fail. We should assume that the chop zone will continue until we start to see whether the Fed/inflation/interest rate combo starts to have negative effects.

Either way, we expect that increased volatility will continue for a while longer.

Bottom Line

There are risks out there right now. Major risks that should not be ignored.

But there are still reasons to not bury your cash in cans in the backyard, at least not yet.

At this point, most clients have roughly 20% of their portfolio that normally would be allocated to stocks in cash right now.

If markets do fall further, we want to be able to have cash available to take advantage of that decline. Which is why we created the ability to move to cash as a part of our base investment process.

And during times like these, it is imperative to have a process.

We find comfort in our processes, because we know we don’t have to try to predict or guess what will happen next. There are no perfect investment systems, and we don’t claim to have one.

Be creating a process, we like to think that we are smart enough to know we are fools, as Shakespeare references.

The primary focus is to avoid big declines in your portfolio. We can’t avoid declines in general. There will always be volatility, and account values will go up and down. No process can avoid that.

When the market is choppy and messy like it is now, we can get signals that are quickly reversed.

That’s okay, in our opinion.

Because at some point a trend is going to reassert itself, either higher or lower.

And when that happens, we have confidence that we can identify it and either benefit from a positive trend or avoid the large downtrends.

In the meantime, we’ll remain diligent and make adjustments to your portfolio as our signals tell us to.

As always, please do not ever hesitate to reach out with questions.

Invest wisely!

Estate Planning for Small Business Owners

Building a business is all about taking risk. You put your belief in yourself, your money, time, and more on the line to create something that can grow and succeed.

But whether your business will fund your retirement plan, or you hope to create a multi-generational family enterprise, there’s one area of risk you shouldn’t be taking.

If you own a business, you need an estate plan. And not just any plan. It needs to cover your wealth and safeguard your family. It also needs to ensure that the business can carry on or that there is an orderly plan for a sale or wind-down.

You’ll most likely need to consult with a financial advisor, a trust and estates attorney, and a tax accountant to get a comprehensive plan in place.

But here are five things to know about creating an estate plan as a business owner.

1. Start with the Foundational Documents

At a minimum, you’ll need a will, a power of attorney, and a healthcare directive, also called a healthcare power of attorney.

The will specifies the disposition of your assets; a power of attorney appoints someone to manage your finances if you are incapacitated, and the healthcare directive appoints someone to make healthcare decisions for you. These three documents ensure that someone you trust can run your business and make decisions.

Wills are a standard estate planning document, and there are some situations, such as appointing a guardian for minor or special needs children, where they are required.

2. Plan for Tax-Efficiency

The current federal estate tax exemption is $12.06 million. This may be above the valuation of your business, so you may not feel tax planning is necessary. However, the current exemption will “sunset” at the end of 2025 and revert to the 2018 level of $5 million, adjusted for inflation.

Estate planning is meant to be long-term and forward-looking. It’s impossible to predict what future tax laws may be with any accuracy, as they are tied to the political climate at both the state and the federal level.

It’s a good idea to build tax efficiency into your plan at every stage.

That may mean creating multiple trusts, managing a business 401(k) plan or cash balance plan, and planning how heirs will pay taxes on inherited property.

Inheriting a business without the means to pay the taxes due would cause an immediate cash crisis, at a minimum.

3. Plan for a Family Succession

If you intend for your children – or at least one of your children – to inherit the business, it’s best to have an unambiguous succession document in place.

Creating a mechanism for dividing ownership while preserving the decision-making powers of whoever will be the chief executive is critical.

You may also want to have documents that specifically keep the business limited to your children only.

top view photo of people handshaking

4. Create a Buy-Sell Agreement

If you have multiple partners and want to avoid disruption, it’s best to get a buy-sell agreement in place.

A buy-sell agreement grants existing owners the right to buy out the exiting owner’s share of the business using a pre-set valuation formula.

5. Life and Disability Insurance Can Protect Assets and Buy Time

Think about who the insured is. Do you need to protect your family or your business?

The correct answer is both, and you need separate policies for each of those beneficiaries. You’ll need a personal life insurance policy and disability policy with your family as the beneficiary to protect them.

To protect the business, you need life and disability policies on yourself and other key people, with the business named as the beneficiary.

The Bottom Line

There’s a lot more to a successful estate plan, but some of it is included in your day-to-day business planning.

For example, let’s assume the intent is to exit the company through a sale. In that case, you should start the process 5+ years from the transaction and incorporate the valuation and other key provisions in with your estate planning, updating the estate plan as information changes.

If you intend to have a multi-generational business, planning to incorporate family members, provide adequate training opportunities, and hand over the reins should also be an ongoing process.

Sitting down with a team including your financial advisor, attorney, and accountant to build a comprehensive estate plan is something you should do sooner rather than later.

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.

Fed Raises Interest Rates: Implications and What We’re Watching

After reducing rates from 2.5% in 2019 to zero at the onset of the pandemic, the Federal Reserve has hiked rates by 0.25%. What does this mean and what should we be watching?

This was about as surprising as dropping a bowling ball on your foot and realizing it hurts.

While there are still MANY risks in the current market environment, this at least removes one uncertainty for now.

The Fed DID raise rates. They DID raise only a quarter-point. And they DID say they were going to raise more this year. (In fact, they hinted that they would likely have a rate increase at each remaining meeting this year).

What does this mean for the markets?

Frankly, not much.

  • Inflation won’t change with a single quarter-point rate increase.
  • Monetary policy isn’t going to change the global dynamics of the Ukraine war.
  • Global supply chains won’t change due to this.

Granted, the mainstream media will make it sound like this is the most important development in the history of mankind, and will bring on “experts” to discuss it ad nauseum. The markets have initially moved higher on this news, which is a good start.

But given the cross-currents around the globe affecting the markets, this interest rate increase is fairly minor in the list of things influencing prices.

As we’ve said many times, markets are extremely complex. Global politics are also extremely complex.

Combine the two and you have an enormous matrix of potential outcomes.

When that happens, it’s best to simplify.

Here is a chart of the S&P 500 Index with the most simplistic view we can think of.

In this chart we show three basic scenarios:

  1. First Bullish Sign: If the market wants to move above the green line (the recent high from early March), then we would have the first sign that a trend change from down to up may be happening.
  2. Chop Zone: In between the green and red lines, there is very little reason to assume the market will ultimately move higher or lower.
  3. Bearish Continuation: If the market falls below the red line, then it is telling us that the volatility is not over and lower prices will follow.

So while we’re in this chop zone, we should consider the daily moves in the market to be noise.

Granted, when markets move 2% and 3% in a day, those are big moves. But until we see a move above or below the levels on this chart, it’s hard to become overly bullish or bearish.

Why do we mark these particular levels? Why might they be important?

Simple: We find it to be an easy way to determine the trend.

In downtrends, each time the market rallies, it stops at a lower level than where it stopped previously. For example, the all-time high was in early January. When it tried to rally in late January and early February, it stopped at a lower price than it was at the start of the year. The same thing happened in early March.

Each time it tried to rally, it made a “lower high”.

Having “lower highs” is the ultimate characteristic of a downtrend. And the market has definitely been in one since the first of the year.

The market can’t sustain a move higher if it doesn’t stop going down. (Thank you in advance for the Nobel Prize in Economics for that statement.)

On the flip side, if the trend of the market continues to move lower, it will make a new low in price below the red line.

That’s another characteristic of downtrends…lower lows.

We use more complex tools than this in our investment process. But this is one ways for you to think about the current market environment.

What are we Watching?

We’ll talk about this more in the coming weeks, but there are some major developments that we are watching right now.

I. Ukraine

This obviously remains the biggest wildcard and by far the biggest risk for markets.

So far, the market’s low (the red line in the chart earlier) occurred the morning of the invasion.

If we get a cease-fire, expect markets to respond favorably.

However, we need to be on guard for continued volatility and potentially lower prices if tensions escalate.

II. De-Globalization of the Economy

This is something we have been thinking about a LOT lately. We will discuss it in a future report as well.

One of the concerning outcomes of the sanctions imposed against Russia is that we have seen a shift to protectionism across the globe.

The globalization of the world economy that began post-World War II was designed to reduce the likelihood of another global war. The idea was that if countries were economic partners, they would have vested interests in maintaining peace.

So far, it has worked.

But since the sanctions were announced, multiple countries have decided to reduce trade. This has the potential to further reduce global supply of everything from oil to grains to semi-conductors.

Maybe these countries are simply responding to inflation and taking a temporarily cautious stance. If reduced trade is a temporary action, then things may go back to normal if inflation falls over the next few months.

However, if we are at the start of a longer-term cycle of de-globalization, there are many negative outcomes that could occur.

These include stubbornly high inflation, shortages of various goods, increased social unrest across the globe and a higher likelihood of more wars.

III. Stagflation

This is another topic we’ll discuss in a later report, but stagflation is becoming a real possibility now.

Stagflation occurs when inflation is high but the economy is in a recession.

It seems strange to think that it could occur in today’s world, but the possibility of stagflation is real.

IV. Market Recovery

We’re obviously watching risks, but not everything is bad right now.

Corporate earnings, for example, were at a record high last quarter.

The Leading Economic Index (LEI), as shown in the next chart, is also at record highs.

This chart goes back 20 years.

One thing to not is that leading up to the financial crisis of 2008, leading indicators were showing signs of weakness. In fact, this indicator peaked in mid-2006, more than two years before things really unraveled economically in 2008.

Note: The leading economic index is made up of ten components, including hours worked, various manufacturing data, building permits, stock prices, yields and expectation for business conditions.

Further supporting the potential for optimism is that both corporate and personal balance sheets are strong, employment is good, and the housing market is on fire.

It will be important to see data that includes the Ukraine war, and what affect (if any) it has had on this data in the coming weeks and months. We will especially be watching the earnings reports closely that begin in early April.

So while there are many reasons to be pessimistic, there are reasons the market could recover and move higher for the remainder of the year.

Bottom line

Ultimately, the market price is what’s important.

Let’s keep watching these levels on the market to see if it can sustain a move higher, and we’ll adjust your portfolio accordingly.

Invest wisely!

In Celebration of International Women’s Day: A Look at Financial Milestones in Women’s Lives

International Women’s Day started over 100 years ago as a labor movement in New York City.

Women workers in the needle trades began to demand fair wages and workplace limits and protections. Women did not have the right to vote, so to effect change and call attention to the cause, they organized a march through New York City’s Lower East Side.

From the beginning, women’s day has focused on economic equality across every dimension of life, education, and work.

There is excellent news on increasing women’s participation in traditionally higher-paid, male-dominated professions. The now decades-long focus on encouraging STEM education for girls and women has dramatically increased participation in related vocations.

The U.S. Census Bureau reports that while overall women’s workforce participation is up slightly in the 20 years between 2000 and 2019, certain careers have seen tremendous inflows of women. The number of women becoming veterinarians has doubled. Women are becoming chemists and other scientists, mathematicians, and dentists at impressive growth rates. 

As women enter higher-paid professions at increasing numbers, they lower the gap between male and female salaries. And as women are creating their wealth, they are doing it in ways that reflect their lifelong needs, habits, and goals. These are – and should be – different from men at every life stage.

Here’s our round-up of some things women should consider as they work to create lasting wealth at every stage of their financial journey.

The Early Stage of Your Career

Income has likely increased substantially, but debt is often still significant at this stage. One other danger is “lifestyle inflation” – being careful to live within your means and save for the future is the foundation of wealth. Your goal in this stage is to create financial security as a baseline and then work to build flexibility. You may want to change careers, go back to school, even take time off. Saving and investing can make those choices possible.

  • Lower Debt. Strategies to lower debt quickly include refinancing to a lower interest rate, paying more than the minimum every month, and automating your payments.
  • Create a Cash Flow Plan. This isn’t about budgeting – it’s about lining up your money with your short- and long-term goals. Especially if you have lumpy income from bonuses or variable work hours, you’ll want to map out a strategy to put your money to work. Hint: open separate bank accounts to align with goals.
  • Take Advantage of Employee Benefits. Employee benefits are where it’s at to increase income and reduce taxes. Contribute at least enough to a 401(k) to get the employer match and strive for 15% of salary. Take advantage of healthcare and commuter benefits.
  • Begin Saving. Saving into an emergency fund is critical. Automate the process until you have 3-6 months of saved income.

The Mid-Career Stage

For most women, mid-career is the busiest stage. You’re focused on work, but you’re also likely getting married, having kids, buying a home, etc. Besides being the mainstay of your partner’s and kid’s lives, you need to be the CEO of your career to be sure you get paid what you deserve and that you can have the career flexibility you want.

  • Love and marriage (and finances). Yours, mine, and ours is how you create trust and set a precedent for open, honest conversations about money and goals. Begin the conversation before you get married.
  • Maximize retirement savings as soon as possible. Women have longer retirements. If you’ve left the workforce and your spouse is still working, contribute to a spousal IRA annually to keep retirement saving on track.
  • Put Investing on a Schedule. Open a taxable investment account and set up an automatic contribution schedule. Be thoughtful and understand your risk parameters – but get invested.
  • Proactively Advance your Career. Benchmark your career every year. Don’t wait to get promoted or get a raise. You can hire a consultant, build a relationship with a good recruiter, or use Linkedin effectively.

Retirement Planning

It’s finally here! You’ve built a solid retirement savings account; now you’re ready to enjoy your new life. Setting up income in retirement looks different for women than for men, because of their longer life expectancy. Think through:

  • Social Security Income. Delay claiming social security if possible. This can provide a much larger lifetime benefit.
  • Consider working for a few years. Social security bases your benefits on your 35 highest-earning years, so replacing an early career year with a much more highly paid later year can bump up your payments.
  • Life Insurance. If you’re married, think about a spousal life insurance policy.
  • Long Term Care Insurance. Get a long-term care policy in place.
  • Estate Planning. Update your estate plan and talk through everyone’s wishes for what will happen as you age. Doing it now while you’re healthy and creating a funding source will help ensure a graceful, happy older stage.

The Bottom Line

Women continue to make tremendous progress on all fronts while guiding and leading us towards a more inclusive world. Taking time to take care of your finances at every stage can put you on the path to lasting wealth.

This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here.

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.