We have a great team here at Provident, and I’m proud of the work each of them does. Our clients see the trades we make in their portfolios, and they read Investment Comments, Viewpoint, and quarterly letters authored by our portfolio managers. But there is a broader team behind the scenes. I’d like to share a bit about each of them so clients can see how our company functions.
Read MoreInvestors in long-term bonds feel like they are repeating a bad song while investors in stocks are likely not doing as well as the media headlines assume.
In 2022, the Federal Reserve began its campaign to tame inflation by increasing the Federal Funds rate from zero to 4.25% by year end. The 10-year Treasury followed, ending at a yield of 3.88%, up from about 1.5% at the start of the year. Because the price of a bond moves opposite to yields, this dramatic increase in rates led to double-digit losses for bond investors.
After a bit of a reprieve in 2023, bond investors are feeling the pain again. The 10-year Treasury yield fell to 3.25% in April but has since steadily increased to about 4.8%, as the Fed has further increased the Federal Funds rate to 5.25%. With inflation still above the Fed’s 2% target and economic growth strong, it isn’t likely that bond investors will escape another year of losses.
Read MoreI recall a television advertisement years ago featuring legendary investor Peter Lynch. Lynch helped popularize the “growth at a reasonable price” (GARP) strategy that Provident largely follows today, registering a sterling track record as the manager of the Magellan Fund at Fidelity between 1977-1990. This advertisement probably aired toward the end of his tenure with the Magellan Fund. In it he emphasized the link between earnings growth and market performance, saying something along the lines of “earnings drive the market.” As an impressionable youth with an interest in the investment business, this message stuck with me. It is something I think most investors generally understand, but the breakdown in short-term correlation between earnings growth and market performance sometimes obscures the tie between the two.
For example, look at what has happened in markets over the past year and a half. In 2022, earnings for the S&P 500 grew 5%, while the market fell 18%. The story in 2023 has been just the opposite, as earnings for the S&P 500 through the second quarter were down while the market advanced nearly 16%. This is not how celebrated market wizard Peter Lynch told us things work! I’m being facetious because what Lynch implied in the advertisement was that while the link between earnings and the market can be tenuous over any shorter period, it generally holds over the longer-term.
Read MoreAs we head into the fall, 2023 has left egg on the face of most forecasters. The seemingly inevitable recession on the heels of a turbulent 2022 hasn’t materialized. The economy continues to grow, inflation is abating, and the stock market has had a remarkable year. Interest rate increases haven’t torpedoed the employment market. Government, consumers, and the market have coalesced around a “soft landing” narrative. However, as always, there are risks.
Since March 2022, the Federal Reserve has executed eleven separate increases to the Federal Funds rate, bringing it to a range of 5.25% to 5.5%. This rapid pace of increases is having the desired impact on inflation and a red-hot labor market.
Read MoreArtificial Intelligence has burst on the scene in 2023, paced by OpenAI, L.P.’s release of ChatGPT (Chat Generative Pre-trained Transformer) last November and Microsoft’s further $10 billion investment in OpenAI that will support incorporating Artificial Intelligence (AI) into current and future products. Investor enthusiasm has been somewhat bubble-like as companies viewed to be on the cutting edge of AI have been rewarded with rich valuations that will only be justified if AI produces profits. It seems that every company has jumped on the AI bandwagon. I can hardly get through the first few minutes of company quarterly earnings or conference presentations without hearing about how they use AI or plan to do so in the future.
For non-investors, I’ve seen and read several articles and blogs speculating that ChatGPT and its further development will eventually lead to Skynet, the fictional conscious-mind AI from the Terminator movies that launched a global nuclear holocaust to destroy its enemy, humanity.
Read MoreLong-term interest rates were choppy with no clear trend in 2023 through the end of July but broke to the upside in August. The 30-year Treasury’s yield recently surpassed its 5-year high of 4.2%, with the 10-year also nudging above 4%. Long-term rates have not traded above these levels for an extended period since the financial crisis of 2008-09. It will be interesting to see whether investors treat this like a ceiling for rates or keep allowing them to rise.
Basic supply and demand for government debt may force a new equilibrium at higher rates, meaning lower bond prices, as the U.S. fiscal deficit will balloon to more than $1.5 trillion in the government’s fiscal year that ends in October. Deficits as a fraction of GDP have averaged 3.6% since 1973. This year’s deficit is likely to be more than 6% of GDP. That is a lot of supply.
Read MoreClients often ask whether Provident can manage the assets in their 401(k) or 403(b) employer-sponsored retirement plans. Until recently, our answer was “no” because we could not trade client accounts custodied outside of Schwab. Assets left behind in a previous employer’s plan could potentially be rolled over into an IRA at Schwab which we could manage. However, with respect to assets in the current employer’s plan the best we could do was to evaluate options and offer a complimentary recommendation for the client to consider. Whether the client acted on those recommendations or revisited the problem in the future as life circumstances changed was beyond our control.
A new technology provider, Pontera, now allows us to trade accounts in employer plans, turning that “no” into a “yes”. Pontera integrates with our reporting system, Tamarac, and allows us to show you a combined portfolio report, including current holdings and historical performance for assets custodied at Schwab alongside those in your employer plan.
Read MoreSince early 2020 the economy has undergone a series of shocks. First came the Covid-19 pandemic, which continues to impact the economy more than three years later. Next came the war in Ukraine, impacting global oil and wheat markets.
Most recently the emergence of Generative Artificial Intelligence (GAI) is a technological development that some have said could be as profoundly positive as the invention of the internet, mobile devices and cloud computing. Only time will tell if GAI lives up to the hype, but these shocks have brought tremendous volatility to the economy and financial markets.
Unprecedented monetary and fiscal support in response to the pandemic has brought elevated inflation. Since March 2022, the Federal Reserve has been pursuing monetary tightening, resulting in the fastest pace of rate hikes in U.S. history, eleven separate increases bringing the federal funds rate to a range of 5.25%-5.5%. The Fed is attempting a soft landing for the economy, raising rates just enough to slow growth without causing a recession.
Read MoreMost of you do not know me, but I have been behind the scenes at Provident for almost 25 years. Scott Horsburgh asked me to share my observations with clients following my retirement on June 30th.
When I joined Provident Investment Management in October of 1998, the company was Seger-Elvekrog, named after its founders. I interviewed with Ralph Seger, Maury Elvekrog, and Scott. Ralph was pleasant with his wonderful reassuring smile, and it was apparent his mission was to share his gift of successful investing. Maury was eloquent, easy to talk to, and then presented me with a psychological multiple-choice test with his charming smile.
Read MoreThe U.S. economy is still feeling the after-effects of the Covid emergency more than three years after it began. In the early going, consumers hoarded items they feared would be in short supply like toilet paper and cleaning products. Demand for many types of services like travel and dining collapsed. In the next phase, component shortages caused prices of many goods to surge. Then, as Covid restrictions eased and demand returned, labor shortages led to further price increases. The war in Ukraine exacerbated growth and price challenges.
The government played a role as spending levels and easy monetary conditions were left in place for too long even as the worst of the crisis had clearly passed. The Federal Reserve was caught flat-footed, assuming the nascent surge in inflation two years ago to be “transitory.” It has spent the last year and a half making up for its initial failure, raising short-term interest rates from around zero to 5.00%.
Read MoreI recently became an uncle. Meeting my nephew was a great experience. After I held the little guy for as long as he would let me, his parents put him to bed and we talked about newborn things – how he was eating and sleeping, where daycare costs and college savings fit in the budget, etc. I asked my brother if he had increased his life insurance coverage with the new dependent. I was happy to hear that yes, he took care of this a while ago and hadn’t thought much about it since. That’s how it should go. The sooner you set it and forget it, the lower the cost to you. But it’s important to periodically review your life insurance policy as your life progresses.
Life insurance is not the kind of thing we think about every day. There are no news programs dedicated to daily moves in policy rates or conversion options. For most people, life insurance serves to replace income when one passes away. The risk of losing your life in any particular year is low, but the financial severity of the loss is high, larger than the accidental loss of your home or automobile. For risks with those characteristics it’s smart to transfer the risk to a third party. Customers pay the life insurance company a premium to assume that risk.
Read MoreThe chattering class in the media and in Washington D.C. is wailing about the debt ceiling, but stock and bond market behavior suggests little concern. Treasury Secretary Janet Yellen says that there is only enough financial flexibility to avoid default until early June, so this matter is coming to a head. President Biden and the Democratic Senate insist on a “clean” bill to raise the debt ceiling which seems unlikely to pass the Republican-controlled House. Republicans insist on spending cuts and a slowdown in future spending growth as a condition of raising the debt ceiling.
The concept of a debt ceiling has not always been part of U.S. finance. From the founding of the Republic until 1917, each and every bond issuance was approved by Congress. Article I of the Constitution specifically empowers only Congress “To borrow money on the credit of the United States.” During World War I, Congress enacted the Second Liberty Bond Act, permitting the Treasury Department to borrow without prior congressional authorization, as long as total debt didn’t exceed the approved amount. The debt ceiling was born.
Read MoreA new chapter in the history of American bank regulation began the night of Wednesday, March 8. That’s when Silicon Valley Bank revealed that the need to raise cash to meet customer withdrawals forced it to book $2 billion in losses on the sale of securities, leading it to look for more capital. Less than 48 hours later, regulators shut down the bank as it lacked sufficient liquidity to satisfy withdrawal demands. An incredible 96% of its deposits exceeded the FDIC insurance limit of $250,000 per depositor. Shockwaves rippled through the bank system. Clients asked us whether their banks were safe, even behemoth Chase.
Over the past 40 years, we’ve had the “Latin American debt crisis” in the mid-1980s, the “savings and loan crisis” in the late 1980s-early 1990s, the Global Financial Crisis in 2008-2009, and now this mini-crisis. Regulatory changes are made after each one, but we always end up back in the soup! Many blame this crisis on changes to bank regulations in 2019, but in fact there is plenty of blame to go around.
Read MoreThe Economist, a British news magazine, put a cowboy on the cover of its April 15 issue and sang the praises of America’s resilient economy. They wrote, “America remains the world’s richest, most productive and most innovative big economy. By an impressive number of measures, it is leaving its peers ever further in the dust.”
Indeed, while Britain and much of continental Europe are experiencing recession, U.S. GDP expanded 2.6% in the fourth quarter, with the Federal Reserve Bank of Atlanta forecasting 2.5% growth for the recently-completed first quarter. After a volatile period during the pandemic, we appear to be regaining our old form of consistent real GDP growth above 2%. Although some forecasters are contemplating a late-year recession, almost no one expects a deep or long-lasting one.
Read MoreThe original “Setting Every Community Up for Retirement Enhancement Act” (SECURE Act) was signed into law on December 20, 2019. A new bill dubbed Secure Act 2.0, was introduced in November of 2022 and signed into law on December 29, 2022. The intention of the law is to build upon the existing Secure ACT by improving retirement savings opportunities. The recently adopted provisions offer new benefits to employers and employees in order to generate greater participation in retirement plans. Secure Act 2.0 will be a rolling process, where enhanced features will be implemented over the course of several years. There are 90 provisions in the updated Act; we will cover some of the key retirement provisions that have the broadest impact.
Changes to Required Minimum Distributions
The Original Secure Act raised the age for required minimum distributions (RMDs) from Traditional IRA accounts and workplace retirement plans to 72 from 70 ½. Effective January 1, 2023, the age for RMDs has been further increased to 73 and on January 1, 2033, the threshold age for RMDs will be increased to 75. In addition, the penalty for failing to take an RMD decreased to 25% from 50% of the undistributed amount. The penalty is further reduced to 10% if the undistributed portion of the RMD is subsequently taken in a timely manner. As for RMDs from inherited IRAs, these were eliminated with the original Secure Act, the only requirement was that an IRA had to be liquidated by individual beneficiaries within 10 years of the date of the original owner’s death. Secure Act 2.0 lacks clarity whether annual RMDs will be reintroduced alongside the 10 year liquidation requirement. Finally, starting in 2024, Roth accounts in workplace retirement plans will not be subject to RMDs.
Read MoreThe bill has seemingly come due for the Federal Reserve’s mistaken belief inflation was “transitory.” A late start in tightening policy to combat inflation led to the fastest rate hikes in forty years, and it should come as no huge surprise the stress from such a move might break something. The collapse of Silicon Valley Bank (“SVB”), the 16th largest bank in the U.S., was the headline casualty, but Signature Bank was also shut down by regulators and the impact was evident across the sector, notably regional banks where share prices declined sharply.
Given the potential for widespread market disruption, regulators stepped in with a package of emergency measures to calm fears among depositors and help prevent contagion. The actions taken brought back unwelcome memories of the financial crisis. The government announced the FDIC would guarantee all deposits held at SVB and Signature Bank, even those beyond the $250,000 limit, by invoking a “systemic risk exception.”
Read MoreWe are approaching the ten-year anniversary of Detroit’s 2013 bankruptcy filing. In light of 2022’s market downswing, as well as recent high inflation, this could be a useful time to brush up on the history of Detroit’s bankruptcy, as other distressed municipalities could find themselves in jeopardy in the future.
With over $15 billion in obligations at the time of filing, Detroit became the biggest municipality in U.S. history to file for Chapter 9 reorganization. Technically, that record still stands today, although in 2016 Puerto Rico began a process resembling bankruptcy, governed by a special act of Congress abbreviated PROMESA. States and territories do not currently have an avenue for bankruptcy, but the path for cities is well established under Chapter 9.
Read MoreThe year is off to a better start for equities than many expected following a difficult 2022 when aggressive rate hikes to counter inflation weighed on sentiment. The move higher for stocks in 2023 has been prompted by the expectation that the Federal Reserve is nearing the end of its rate hike cycle as inflation retreats from its recent peak. Combine that with optimism regarding a reopening in China and a resilient labor market in the U.S., increasing hopes for a “soft landing” for the economy, and the move higher for equities is understandable.
To battle persistently high inflation the Federal Reserve has raised its benchmark interest rate by 4.5% since last March, to a range of 4.5%-4.75%. This represents the fastest pace of rate increases since the 1980s with the intention of cooling off the economy to bring down inflation. The tagline the Fed uses is that its policy operates with long and variable lags, but still, its efforts have not yet had quite the bite many expected.
Read MoreIn a reversal of a long, consistent trend, we just experienced a year where “value” stocks outperformed “growth.” In 2022 the Russell 1000 Pure Value index lost 8% while the Russell 1000 Pure Growth Index fell 38%.
Though they are widely used, I’ve never been fully comfortable with these classifications. To be fair, the labels serve a purpose, as people generally understand what they mean. “Value” typically implies something along the lines of a company with a low price-to-earnings ratio or a low price-to-book value. Growth, I think, is self-explanatory. While conceding these can be useful labels, they ignore important nuance and can be misleading.
Read MoreLast summer, there was a brief wave of optimism among investors that the Federal Reserve’s pattern of interest rate hikes would be short-lived. It was illogical given rampant inflation, but investors could let their imaginations wander during the lengthy eight-week lull between the Fed’s July meeting and its September meeting. However, midway through the lull the Fed became concerned investors weren’t getting the message, using the annual “Jackson Hole (WY)” monetary policy conference in late August to reiterate its determination to raise rates until inflation is back to its 2% objective. Investors got the message and stock and bond prices wilted for about a month and a half afterward.
A greater disconnect between markets and the Fed emerged after markets bottomed in mid-October, persisting even in the face of two more Fed meetings that resulted in rate hikes. Notes from its November meeting indicate Fed governors raised their terminal Fed Funds rate in this tightening cycle compared to their consensus after the previous meeting. Markets initially flinched on this news, but quickly resumed their ascent.
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