News & Insights

Wall Street’s machinery has been calibrated to encourage activity from investors, often to their detriment. To prod action, there are Wall Street analysts recommending “buys” and “sells” on individual companies along with a parade of market strategists who appear in the media to suggest the right strategy for the moment. As one example, Barron’s recently ran its Fall Market Outlook, which helpfully included a “shopping list for fall,” highlighting sectors strategists recommend overweighting and underweighting. Though many of these strategists are thoughtful and smart, and I often find value in understanding their rationale, I wonder who acts on these recommendations. I envision someone reminiscent of the woman from the Interactive Brokers’ commercial a few years ago who had to excuse herself while at dinner with a companion in order to make some “hedging trades” on her phone in response to some breaking news.

I try not to be an investment snob, turning up my nose at those who choose to pursue a different path than we do at Provident. We have time-tested reasons for our process, and ultimately believe our strategy positions clients well for achieving their desired long-term outcomes. That doesn’t mean it is the only way or that you can’t find success YOLO-ing options on meme stocks such as GameStop or by investing in your favored cryptocurrency. I would argue those paths make achieving long-term financial goals significantly less likely, but as the recent environment has shown, under the right circumstances one can find tremendous success. We view investing as a serious business, yet that doesn’t prevent us from finding humor when someone makes a life-altering sum of money thanks to a cryptocurrency based on a dog that initially was intended purely as a joke.

I got together with a few other neighborhood dads recently to play a board game called Q.E. The name is short for “Quantitative Easing,” a term that entered the public conscious when Ben Bernanke’s Federal Reserve started buying investment securities to improve banks’ balance sheets during the financial crisis of 2008-09. The game was published in 2019, and while its theme harkens back to 2008-09, it also accidentally anticipated the Covid-19 pandemic.

Players assume the roles of central bankers around the world competing to bail out too-big-to-fail national industries, printing huge amounts of money in the process. One of the game’s rules is that the player who prints the most money destroys his or her national currency and automatically loses the game. The strategy is to abuse your national currency as much as possible without totally destroying it. It is funny how this game mechanic seems to agree with the incentives that drive real-world governments and central banks. Its designers must know a thing or two about political economy. Throughout history, governments have almost universally favored higher inflation while trying to avoid the disruptive and humiliating consequences of straying too far into hyperinflation.

As Miles discussed in this month’s Investment Comments, inflation has reared its ugly head for the first time in many years. For those of us that remember the 1970s “stagflation,” a combination of persistently high inflation paired with slow economic growth, just the word “inflation” brings to mind poor stock returns. Let’s delve a bit deeper into the damage inflation causes, why it has spiked, the prospects for the spike to continue, and our thoughts on what you should do with your portfolio, particularly your stock allocation.

Why is Inflation a Problem?

Rising inflation causes problems for everyone. For consumers, the ability to purchase goods and services is reduced as the currency they hold is no longer worth what it was in the past. Businesses endure two negatives: revenue can be suppressed as consumers can’t buy as much as they could before, and input costs are now higher, hurting profits. The overall economy slows until everyone has adjusted to the new price levels. If inflation is persistent these impacts are reinforced as workers demand higher wages to offset the reduction in purchasing power and business profits take a further hit from the higher wage cost. In the 1970s persistent inflation, exacerbated by higher energy input costs from two oil shocks, created stagflation as the economy never got a chance to fully adjust.

It is estimated that over the next two decades, Baby Boomers will pass down a whopping $68 trillion worth of assets to younger generations. Receiving an inheritance should be considered a blessing, but if not handled correctly it can quickly become a curse. If you’re not careful, you run the risk of losing your money just as quickly as you receive it. According to a study conducted by the Bureau of Labor Statistics, one-third of people who receive an inheritance spend all of it in the first two years. With some sensible planning and foresight, you can make sure that your inheritance takes care of you and your family long after you receive it.

Here are some ideas to help set you on the right course with your newfound wealth.

First, take time to grieve and don’t make decisions right away. When you lose a loved one, you’re not thinking clearly enough to make sound financial decisions. Deciding what to do with an inheritance during this period can be overwhelming, upsetting, and cause confusion. There is nothing wrong with letting your inheritance sit for a while until you are ready to focus and develop a plan.

Work continues in earnest on the transition to Schwab. There is a lot of preparation that goes into changing custodians. This is often referred to as “repapering” in the industry, as every account requires new paperwork. There is the logistical challenge of gathering information for each client and each account in a practical format. There is the professional challenge of interacting with a new customer service team and a new software interface. Most importantly, there is the challenge of providing consistent service to clients and making the process as seamless as possible.

I will not rehash our explanations for making the transition, but I will give you an update on where it stands and why we have been asking you to confirm personal details that may seem trivial or unrelated to investment strategy. Our goal remains to complete the process mostly digitally. Our clients have been willing and helpful participants to that end. We plan to continue utilizing digital forms and signatures in our normal course of business, when possible. Reducing analog paperwork between you and your custodian should improve speed and efficiency.

It is said that 70%-90% of new businesses fail within a decade. Imagine our pride that the little investment business founded by Ralph Seger and Maury Elvekrog on July 29, 1981 will soon celebrate its 40th anniversary!

Allow me to share a trip down memory lane, 40 years of history in a 10-minute read. After successful careers as a chemical engineer and industrial psychologist, respectively, Ralph Seger and Maury Elvekrog took their hobby of stock investing to the next level. Both began working for a local investment firm and quickly realized their investment philosophy and client focus were more aligned with each other than with their employer. Seger-Elvekrog Inc. soon followed.

Imagine the boldness to start a new investment business in 1981 in the midst of back-to-back recessions and bear markets! In retrospect, it was a wonderful time, as the United States was on the cusp of a long bull market lasting almost two decades with only brief interruptions.

“People say that life is short, but it isn’t short. It’s very long.”

-Frank Abagnale

The battle cry of the modern speculator is “YOLO” meaning You Only Live Once. It is a kind of greedy twist on the “Carpe Diem” motto that Robin Williams invoked to motivate lackadaisical adolescent boys in Dead Poets Society. YOLO is obsessed with money—grab it all now before you die. People don’t yell “YOLO” when they give money to a charity or finish a challenging book. They could, but they don’t. They yell YOLO when they sink their annual bonus into cryptocurrency, or maybe when their broker approves a margin loan application. This greed is combined with a sort of nihilism—who cares if things don’t turn out how you’re hoping? In their view, living is doing outrageous things for a slim chance at a miraculous payday. I wonder what everybody will be yelling when it stops working?

2020 was a very strange year for markets. Over the past year we likely set a record for the use of the word “unprecedented” on earnings calls. I suppose a pandemic combined with meaningful amounts of global monetary and fiscal support will do that. Going into 2020 analysts expected 5% revenue growth and 9% EPS growth, leading to an approximate 5% increase in the S&P 500. This was not particularly noteworthy, as the default estimate for growth in the S&P every year is a mid- to high-single-digit percentage gain. Though the final numbers for 2020 have yet to be counted, expectations are for a 1% revenue decline accompanied by a 13% drop in EPS, well below initial expectations. Meanwhile, the S&P 500 advanced by a better-than-expected mid-teens percentage. This goes to show the extreme difficulty in making forecasts, yet Wall Street continues to try.

Happy New Year! If you are like me, I bet you are glad to wave the year 2020 goodbye as it has been one of the saddest and strangest of times for our country. If you have lost a loved one or friend to COVID-19, please accept my condolences. Let us all wish for a speedy rollout of vaccines that bring this pandemic to a swift close.

As for the economy and investing, COVID-19 caused both predictable and surprising impacts. On the predictable side entire sectors of our economy, particularly hospitality and travel, fell into deep recession and will likely not reach 2019’s level of activity for years. Social distanc­ing accelerated trends that were already in evidence such as buying online, remote work, and entertainment on demand via streaming. Shutting down the economy to fight the virus led to recession and a bear-market drop that registered more than 40%, ending the longest bull-market in history at eleven years.

2020 will be remembered as a year like no other. A year that started out with a global pandemic and ended with a presidential election. A year that saw the stock market contract to bear market levels from record highs, only to rebound and set new record highs. However, with all the unexpected changes around us, one important task remains constant, year-end financial planning. As always this will help you better organize your financial health and start off the New Year on the right foot. Here are some key topics to consider addressing.

Gifting strategies

Whether you give to a loved one or to a charitable organization that is close to your heart, ‘tis the season of giving gifts. If you choose to give a gift to an individual, keep in mind that gifts up to $15,000 per person are allowed under the annual gift tax exclusion. Consider gifting assets that have the greatest potential for appreciation in order to optimize the tax savings.

From time to time, I like to update clients as to what is happening behind the scenes here at Provident. We’ve made a number of technology changes over the past year or so, and you might find it interesting to learn how things gradually evolve here. We are not “early adopters” of technology. We tend to wait a bit and let others work out the kinks on brand new offerings.

The impetus for this piece is an important change to our client accounting system. After almost 22 years with PortfolioCenter, we are switching to Tamarac Reporting. Portfolio­Center was a reliable software package, but began to show its age in recent years as owner Charles Schwab Corp. seemed to stop investing in it.

About two years ago, Schwab sold the Port­folioCenter business to Envest­net/Tamarac, a publicly-traded software company focused on the investment industry. The buyer had been using PortfolioCenter as the backbone of its own online portfolio accounting soft­ware, and was the logical buyer when Schwab wanted to exit that business.

To say this has been an interesting year for the market would be an understatement. After the swoon in March due to the pandemic, we recovered the entirety of the downturn and then some. There have been only a few market declines of similar magnitude over such a short timeframe, and the abruptness of the snapback has surprised many, especially given what are likely to be longer-lasting effects on the economy from COVID-19. To be certain, fiscal and monetary stimulus have played a significant role in supporting the economy and aiding the market’s recovery. Interest rates have declined, helping make the case for higher P/E multiples. Lower interest rates reduce the rate at which future cash flows are discounted, raising asset prices in general. However, while a portion of the recent rebound in stock prices looks to be justified, it has been accompanied by some harder-to-explain moves in certain individual stocks, and for that matter certain other assets.

Though more traditionally discussed in relation to bonds, the concept of “duration” similarly applies to stocks. Duration is a measure of the weighted average of when investors receive their cash flows. Though the risk profiles generally differ, stocks and bonds are fundamentally similar. Each produces a stream of cash flows; however, unlike bonds, which have contracted payments over preset intervals, the “payment” on stocks is less certain. Assets that are longer duration are more sensitive to movements in interest rates, deriving greater benefit from lower rates and alternatively selling off more when rates rise. Stocks generally have a longer duration than bonds, and among stocks durations will differ as a result of the anticipated cash flows.

As an investment advisor I worry about inflation a lot. Besides political revolution, no other force turns rich people into poor people as quickly and as surely as inflation. If your income is fixed by a pension or annuity formula which doesn’t escalate along with the cost of living, or if most of your money is tied up in long-term bonds with low yields, then your means will shrink at the pace of inflation. A few consecutive years of double-digit inflation can turn a comfortable retirement into a marginal one if your portfolio does not own enough real assets to defend against it.

Happily, inflation has been predictable and tame for almost 40 years. Consumer Price Index (CPI) inflation has not advanced at a double-digit annual pace since 1981. It has not even been as high as 5% since 1990. Many analysts believe that the CPI’s methodology understates the “true” rate at which prices rise. I agree, but the magnitude of the understatement is probably no more than 1% per year. Buttering another 1% onto the price level annually certainly adds up over time, but it does not change the fact that we have recently enjoyed an era of extraordinarily stable fiat money.

In these unprecedented times, nearly 40 million Americans have lost their jobs in a span of eight weeks. That is more job losses than the last recession saw over two years.

The loss of a job can be a nerve-racking experience, leaving a person with feelings of sadness, anger, and depression. Mourning a job loss is normal; for many it means the loss of their identity and lifestyle. Many professionals feel that other than the death of a close family member or going through a divorce, the loss of a job is probably the single most traumatic event of a lifetime.

We have all been stunned and saddened by the sheer number of our fellow Americans suddenly in need. In the Great Recession of 2008-2009, the number of monthly job losses peaked at 818,000. The recession lasted roughly 18 months with a total of 8.7 million jobs lost. In the month of April, 2020 alone, 20.5 million Americans lost their jobs. That is on top of 881,000 in March with more likely to come in May and beyond. Consumer demand has dropped sharply, creating an environment where businesses needed to cut costs. Also, companies likely furloughed additional employees, knowing that enriched unemployment benefits under a new law would tide them over until businesses re-opened.

Despite government efforts to put money in people’s pockets, there is genuine suffering out there. Seeing pictures of long lines at food banks is reminiscent of the Great Depression.

Many of us who have been fortunate in life are in a position to help, and here are some suggestions:

I spent the last year preparing for the CERTIFIED FINANCIAL PLANNER™ exam. Rather than exploring new music or checking off books from a growing reading list, I studied textbooks, attended virtual lectures, and practiced test questions. In some cases, I was brushing up on lessons from business school or revisiting concepts mastered through professional experience; in others I was learning new material and committing to memory laws and regulations. Throughout the process I analyzed how I could leverage each developing skill for you, our clients.

This effort culminated on March 16 when I passed the six-hour CFP® exam. Upon checking out, the test center administrator quipped, “I hope you don’t have plans to go to the bar.” The governor had just ordered all bars and restaurants closed effective immediately. So much for that dinner out to celebrate! Somewhat unceremoniously, I began life as a CFP® professional.

As tax season winds down and you start digging yourself out from underneath piles of tax documents and financial statements, this makes an ideal time to simplify your finances by consolidating accounts. A great place to start would be with your former employer-sponsored retirement plans. If you participated in a workplace retirement plan such as a 401(k) and changed jobs or retired, you have several options for that plan. You can cash it out, leave it alone, transfer it to your current employer’s plan or roll it over to an IRA. For many, making this decision can be a source of confusion and fear. It is for these reasons, many choose to forgo action, and miss out on opportunities.

In most circumstances, cashing out of your retirement plan is the least favorable of the four options. This is especially true if you are under the age 59 1/2, because you will pay a 10% early withdrawal penalty, in addition to income tax, on the distribution. Also, by cashing out the plan you will lose all future tax deferred growth which could prove costly over the long term.

Eleven years into this bull market, it’s déjà vu all over again. It is starting to feel like we are back in the bubble conditions of the 1990’s, or at least getting there. It is not so much the overall market that has me bothered. I am concerned about specific cases…a lot of specific cases. A slightly alarming number of stocks have come uncoupled from economic reality.

Let me start on a fairly positive note by saying that in the context of prevailing interest rates, overall stock valuations are not crazy—not in most cases anyway. In a world of ultra-low interest rates, it makes sense that stock valuations are levitating above historical averages. According to data from Finviz.com, for the 62 U.S. companies with market capitalizations over $100 billion, the median trailing P/E is 27. This equates to a median “earnings yield” of 3.7%, meaning $100 invested in large stocks is earning $3.70 in corporate profits. That is low by historical standards (valuations are high), but it looks okay compared to 10-year Treasuries yielding 1.4%. It is possible that the market continues to trade at roughly this same valuation for a long time, advancing at the rate that corporate earnings grow. The stock market is one of two places where things can go up without coming back down.

Last August I wrote about bipartisan legislation, the SECURE Act, that had passed the House in May but was stalled in the Senate as a few politicians pursued unpopular changes.  In early December, most of the Senate saw an opportunity to override this gridlock by attaching the bill to appropriation legislation that avoided a government shutdown.  This is how the SECURE Act became law after President Trump’s signature on December 20, 2019. For a summary of its major provisions, please see my August 2019 Viewpoint column under the “News & Insights” tab on www.investprovident.com.

Now that the SECURE Act has passed, I’d like to provide some additional information and comment on steps you might need to take as you think through tax and estate planning.  Before I do that, I’d like to correct one item in the August Viewpoint regarding Roth distributions.  My read of the legislation led me to think Roth distributions would avoid the 10-year accelerated distribution period for non-spouse and other specifically defined beneficiaries.  This is not the case as Roth distributions will be treated identically to traditional IRA distributions.

Americans are generally pleased with the quality of the healthcare they receive, but not its cost.  Healthcare inflation, while moderating during the previous decade, continues to outstrip overall inflation.  In response, employers are asking employees to bear more of their own healthcare costs, and government is increasing subsidies to help.

Health Savings Accounts (HSAs) were established as part of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 and evolved from other pretax healthcare programs.  An HSA is a personal savings account funded with pretax dollars that can be used to pay for qualified healthcare expenses.  While the Act is best known for providing a Medicare prescription drug benefit, the HSA has become increasingly popular with both employers and employees as the tax benefits have lowered both parties’ healthcare costs.