Compardo, Wienstroer, Conrad & Janes at Moneta

Monday, March 20, 2023

“March Madness” Continues: Credit Suisse Succumbs to Crisis of Confidence

Chris Kamykowski, CFA, CFP®, Head of Investment Strategy and Research
Mark Webster, CMFC®, Senior Investment Research Analyst

Markets are currently experiencing an unexpected flashback to the 2008 Great Financial Crisis (GFC) as a handful of banks come under pressure from multiple angles. Luckily for now, we are only dealing with a couple weeks of consternation over the soundness of the banking system versus the persistent late summer carnage that took out financial behemoths such as Merrill Lynch (acquired), Washington Mutual (acquired) and Lehman Brothers (bankruptcy).

One can be forgiven for believing that after the GFC, all the new banking regulations, capital requirements and stress testing would negate the risk of systematically important banks facing critical moments of collapse or forced acquisition. Yet, here we sit nearly 15 years later, the day after UBS Group AG was politely forced to purchase its 167 year old, $500 billion balance sheet rival, Credit Suisse Group AG, after multiple failures last week to stem a crisis of confidence in Credit Suisse.

Despite a $54 billion financing backstop by the Swiss National Bank (SNB) last week, a more intrusive intervention was mounted by the Swiss Federal Department of Finance, SNB and the Swiss Financial Market Supervisory Authority FINMA (FINMA) to help push this deal through on Sunday. Key details of the acquisition include¹:

- UBS to purchase Credit Suisse for approximately $3.3B.
- The Swiss government is providing $9 billion to offset potential losses UBS may incur as part of the purchase.
- SNB is providing $100 billion of liquidity to UBS to help move the deal through to completion.
- Importantly, Credit Suisse continues to operate in the ordinary course of business and implement its restructuring measures in collaboration with UBS.

Separately but related, starting today and lasting through April, the Fed — alongside the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank — are expanding the frequency of dollar swap line operations². This is likely a step to continue to reduce the concern over contagion; it allows foreign central banks to supply dollars locally to serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses.

Market Response

After the news on Sunday, Europe was better bid as the FTSE 100 and DAX indices were up 0.93% and 1.12%, respectively. Importantly, UBS stock closed up just over 3% today and the STOXX Europe 600 Bank index was up 1.5% as well. Other overseas markets finished Monday mixed with the Hang Seng and Shanghai Composite indices down -0.5% to -2.7%, respectively.

In the US, as of market close, equity markets experienced modestly positive relief with the Dow Jones higher by 1.2% and S&P 500 index up 0.89%. US small cap equities, as represented by the Russell 2000 index, were higher by 1.11%. The violent bond market rally seen recently reversed course – at least for the moment – as risk-free asset yields moved higher with the US 2-Year and US 10-Year Treasury bonds up 0.14% and 0.06%, respectively.

Comments

While these extraordinary efforts may calm markets for now, there are clear losers in this deal. Credit Suisse equity holders, while lucky to avoid outright bankruptcy, have seen the market value of their holdings cut substantially versus Friday’s values. The approximately $17B of Additional Tier 1 Capital will be written off to zero¹. These perpetual bonds were issued to help meet Tier 1 capital ratio thresholds but were of lower quality given they were subordinated to all other debt. A potential winner is UBS which could be the phoenix from the ashes, as it now takes hold of a valuable wealth management franchise and near monopoly in Swiss banking.

The shift in the recent narrative from banks such as Silicon Valley Bank and Signature Bank to Credit Suisse is stark and sure to lead to continued trepidation by investors over the near term. While it had a storied history and larger balance sheet, Credit Suisse was plagued more recently by leadership turnover, legal issues, risk management and regulatory setbacks which made them vulnerable to a loss of confidence, which had already been eroding. Deliberate and decisive action was needed as the bank was hemorrhaging $10 billion a day in deposits after seeing $120+ billion exit in late 2022. More importantly, action was needed to contain declining confidence in the banking system at large.

On a side note, Credit Suisse’s 2022 annual report was released earlier this month. The CEO and Chairman closed their opening statement stating, “With a new and highly experienced leadership team, which has a proven track record in the delivery of restructurings and executing to plan, we believe we have the right team in place to achieve the strategic, cultural and operational transformation of our bank. Since October 2022, this team has been executing our strategy towards the new Credit Suisse at pace and with full dedication and commitment. Together, we will work hard to restore trust and pride in Credit Suisse, to create value for our clients and to deliver strong returns for our shareholders.”³

Unfortunately, time ran out for this plan to pan out for the new leadership team as the market, customers, their rival and government entities forced their hand.

What Now?

Near term, fear will still dominate as contagion concerns persist. This will likely heighten downside risk as markets assess the extent of more collateral damage relative to actions taken to stem the impact of recent banking troubles. Fear of a 2008-esque repeat will permeate narratives but it is important to note 2008 saw an economy actually in a recession, a complete collapse of the housing market, and widespread deleveraging across consumers and businesses. For now, the issue here is a crisis of confidence in the banking system which sees central banks and governments acting decisively to contain. The economy remains strong, labor tight, and corporate and consumer fundamentals are in a better position than in 2008.

The FOMC will be meeting early this week (3/21 & 3/22) for its regularly scheduled meeting which will likely prove interesting as they debate the next move: continue to hike given inflation or pause to give the market a reprieve from the current volatility. Neither choice is without downside: hike and the market could fall due to what is characterized as a tone-deaf response by the Fed. Pause and the Fed’s credibility is challenged as their data dependent approach reacts to items outside their charge of price stability and full unemployment. The Fed warned markets about the pain that could come from upending years of accommodative monetary policy and we are certainly in the midst of acute pain that will test the Fed’s resolve it just recommitted to a couple weeks ago.

That all said, this is still a very fluid environment with an evolving narrative which we will be monitoring as things transpire.

Sources

Bloomberg

1 – https://www.credit-suisse.com/about-us-news/en/articles/media-releases/credit-suisse-and-ubs-to-merge-202303.html

2 – March 19, 2023 Press Release : https://www.federalreserve.gov/newsevents/pressreleases/monetary20230319a.html

3 – 2022 Annual Report: https://www.credit-suisse.com/about-us/en/reports-research/annual-reports.html

Definitions

The DAX is a stock market index consisting of the 40 major German blue chip companies trading on the Frankfurt Stock Exchange.
The Dow Jones Industrial Average, Dow Jones, is a stock market index of 30 prominent companies listed on stock exchanges in the United States.
The Hang Seng Index is a free float-adjusted market-capitalization-weighted stock-market index in Hong Kong.
The Russell 2000® Index is an index of 2000 issues representative of the U.S. small capitalization securities market.
The Shanghai Composite Index is a stock market index of all stocks (A shares and B shares) that are traded at the Shanghai Stock Exchange.
The S&P 500 Index is a free-float capitalization-weighted index of the prices of approximately 500 large-cap common stocks actively traded in the United States.
The STOXX Supersector indices track supersectors of the relevant benchmark index. There are 20 supersectors according to the Industry Classification Benchmark (ICB). Companies are categorized according to their primary source of revenue.

Disclosures:

Trademarks and copyrights of materials referenced herein are the property of their respective owners. Index returns reflect total return, assuming reinvestment of dividends and interest. The returns do not reflect the effect of taxes and/or fees that an investor would incur. Examples contained herein are for illustrative purposes only based on generic assumptions. Given the dynamic nature of the subject matter and the environment in which this communication was written, the information contained herein is subject to change. This is not an offer to sell or buy securities, nor does it represent any specific recommendation. You should consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. An index is an unmanaged portfolio of specified securities and does not reflect any initial or ongoing expenses nor can it be invested in directly. Past performance is not indicative of future returns. All investments are subject to a risk of loss. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. These materials do not take into consideration your personal circumstances, financial or otherwise.

The post “March Madness” Continues: Credit Suisse Succumbs to Crisis of Confidence appeared first on Moneta Group.

source https://monetagroup.com/blog/march-madness-continues-credit-suisse-succumbs-to-crisis-of-confidence/

Ask the CFP® – When should I take Social Security?

Hello! This month’s Ask the CFP ® question is “When should I begin taking Social Security?” This is a question we hear often, and the answer is…it depends.

You can begin drawing Social Security benefits anytime between the ages of 62 and 70. However, depending on your overall wealth, the timing can make a significant difference in your lifetime retirement income.

For anyone born after 1960, 67 is considered full retirement age. Your benefits will either be reduced, if you begin taking social security before the age of 67, or enhanced if you wait until after. If you were born before 1960, your full retirement age is between 66 and 67, and similar rules apply.

Let’s say your full retirement age is 67, and you begin taking social security at the age of 62 – that would reduce your benefit by 30%. On the other hand, for each year you wait beyond the age of 67, you receive an extra 8% in benefits.

Here’s an example…

Imagine a married couple decides to retire at age 62. The wife was a corporate executive and the husband was a freelance graphic designer. Her Social Security benefit is much larger than his because of their earnings history.

If they both take their Social Security beginning at age 62, they’ll have a reduced benefit for the rest of their lives. Of course, they know they can delay their benefits, but they want to start enjoying the income now.

In this scenario, they might decide to file for the husband’s benefits at age 62 and delay the wife’s benefits until she turns 70. This way they can maximize her benefits, while supplementing their income with the husband’s social security immediately. If the wife were to pass away at age 72, the husband would be able to take over his late spouse’s larger benefit for the rest of his life. This strategy would avoid an early penalty on the wife’s benefit and increase the benefit by 24% for waiting until age 70.

With inflation at highs not seen since the early ‘80s, it’s important to also remember that Social Security adjusts with inflation. If you collect Social Security for 20 or 30 years, the cost-of-living adjustment can grow your benefit significantly. Without that adjustment, your Social Security benefit would be eroded over time due to inflation. It would be like working at a company for 20 years without ever receiving a raise! But because of this cost-of-living feature, delaying Social Security for a higher benefit could also offer larger inflation adjustments in dollar terms.

Deciding when to retire is a deeply personal decision that depends on many factors such as your overall assets, your health, and your marital status – whether you are married, can claim as a divorced spouse, or are a widow or widower. A healthy person who expects to live into their 90s may benefit from delaying Social Security until age 70, while someone with poor health may need to draw Social Security as soon as possible at age 62.

Overall, we advise considering multiple scenarios and factors before you decide when to take your Social Security benefits. We’re here to help as questions arise.  

If you have a question about this topic or have a suggestion for a future Ask the CFP ® video, please send it to TFreeman@MonetaGroup.com. Thanks for watching and we’ll see you next month.

The post Ask the CFP® – When should I take Social Security? appeared first on Moneta Group.

source https://monetagroup.com/blog/ask-the-cfp-when-should-i-take-social-security/

Do You Have Non-Qualified Stock Options? A Primer on Non-Qualified Stock Options and Leveraging their Benefits to Build Wealth

By Michael Torney, CFP, J.D., LL.M.

Stock options often make up an attractive component of a senior-level executive’s pay. At most large companies, options are awarded annually as an incentive to help the company meet its long-term profit goals. With sound financial planning, these awards can significantly increase an executive’s wealth.

There are different kinds of stock options with various features, including the amount of taxes paid once the awards are exercised and sold. Two major categories include incentive stock options and non-qualified stock options. This blog explains how to make the best use of non-qualified stock options (NQSO).

What is a NQSO?

A NQSO has three components:

The right to buy a set number of shares of your company’s common stock;
The shares have a set price;
The shares must be exercised within a fixed period.

For example, you may be awarded the option to buy 10,000 shares in common stock at $50 per share. You have up to 10 years to exercise the shares.

The shares also have a vesting period, which is the amount of time required to hold the shares before they can be exercised. For example, if 25 percent of the shares vest each year, it will take four years until you are entitled to all 10,000 shares.

Strategies to Exercise Non-qualified Stock Options

With proper planning, an executive can earn a significant profit. Once the stock’s price rises significantly higher than the exercise price, it may be worth exercising your options. At this stage, you have three options:

Exercise and Hold. You pay cash to your company, receive the full number of shares and hold onto them.
Exercise and Sell. Immediately selling your shares after exercising your options. You will receive the net proceeds after paying the exercise costs. Your company will also withhold money for federal, state and other taxes.
Sell to Cover. Exercising your options, but selling enough shares to cover the option costs and taxes.

Here’s an example showing the differences:

The 10,000 shares granted at $50 per share are worth $500,000. Let’s assume the stock price increases five percent annually during each of the next four years.

After Year 4, when all of the stock has vested, it will be worth $60.77 per share – a total of $607,700. At this point, the profit before taxes is $107,700.

However, you don’t have to cash in yet. You have 10 years until required to exercise the options. If the stock price continues to climb and reaches $75 per share after year 8, the pre-tax profit is now $250,000 – more than double the amount after Year 4. A person could recognize much higher profits by either exercising & holding the stock or continuing to hold (without exercise) their options until Year 8.

Of course, the stock price could also decline at various points during this 10-year period. While no one can accurately predict the timing of a stock’s rise and fall, a corporate executive knows the company’s direction and profit potential. Working together with your financial advisor, you can determine how much money is needed to meet key goals before deciding when to exercise and sell some or all of the shares.

Taxes

When it comes to the amount of taxes to be paid on your gains, timing is important.

The difference between the fair market value of the stock and the cost of the option will be included in compensation income on your W-2 and taxed as ordinary income when you exercise. The fair market value of the stock is then your cost basis for determining your capital gain or loss when the shares are sold.

If the stock option shares are sold less than one year after exercising them, any additional gain or loss from the fair market value cost basis at exercise is short-term capital gain. However, if the stock option shares are sold more than one year after holding them, any additional gain or loss since exercise is taxed as a long-term capital gain.

Long-term capital gain rates are often lower than ordinary income rates for highly compensated executives. The difference is significant. That’s because the maximum federal tax rate in 2023 on ordinary income is 37 percent compared to 20 percent for long-term capital gains (plus 3.8 percent for net investment income tax, if applicable).

Using our previous example, an executive who exercises their options after Year 4 and sells their shares before Year 5 at $60.77 per share has a profit of $107,700 before taxes. The executive will pay 37 percent in federal income tax on the $107,700 pre-tax profit; plus any state taxes, Medicare and Social Security taxes.

However, if they exercise after Year 4, but wait until Year 8 to sell, their $142,300 gain since exercise ($250,000 less the $107,700 taxed at exercise) will be taxed at no more than 20 percent – the capital gains maximum rate (plus 3.8% tax, if applicable).

For some types of non-qualified stock options – those with an early exercise feature – an executive may be able to pair the option with an 83(b) election. This election may save taxes for the executive and is covered in another blog post. Check your employer’s plan document to see if 83(b) elections are permitted on your non-qualified stock options.

Every executive has different financial needs and plans. If you have recently received or currently hold non-qualified stock options and would like to discuss how to maximize the value of these awards, contact our team at Duffteam@monetagroup.com. We work with many senior-level executives and offer a free consultation on how a comprehensive financial plan can help you build financial independence.

The post Do You Have Non-Qualified Stock Options? A Primer on Non-Qualified Stock Options and Leveraging their Benefits to Build Wealth appeared first on Moneta Group.

source https://monetagroup.com/blog/do-you-have-non-qualified-stock-options-a-primer-on-non-qualified-stock-options-and-leveraging-their-benefits-to-build-wealth/

Tuesday, March 14, 2023

Silicon Valley Bank – A Not So Broken Record

Tim Side – Research Analyst

Markets were roiled last week following the collapse of Silicon Valley Bank, the 16^th largest U.S. bank with more than $200 billion in assets. Depositors went into the weekend with little clarity on what the status of their deposits beyond the $250,000 FDIC limit would be come Monday. The turmoil continued to escalate through the weekend, as regulators closed Signature Bank, another large bank with $110 billion in assets. A brief reprieve was felt Sunday evening, when the FDIC released a joint statement by the Department of the Treasury, Federal Reserve, and FDIC, stating that depositors at Silicon Valley Bank and Signature Bank would have access to all funds on Monday. These actions appear to have stabilized markets for the time being, although volatility and uncertainty have significantly increased.

The situation remains extremely fluid. Attempts to provide updates have become quickly outdated as new information continues to be released. While minute-by-minute updates are best provided by major news outlets, we wanted to provide a quick update and look through the noise to see how this might affect our long-term investment thesis.

Historical Context

Bank closures are nothing new, although the number and magnitude of closures has certainly fallen post-Global Financial Crisis (GFC):

Source: FDIC.gov as of 3/10/2023

In most cases, the failed bank’s deposits are assumed by another bank, making depositors whole and helping maintain faith in the U.S. banking system. During the GFC, the government stepped in, taking extraordinary measures to protect “systemically important” institutions. Using lessons learned from the GFC, the Federal Reserve acted quickly and emphatically through the depths of the Covid crisis, and they, in conjunction with the FDIC and Treasury Department, are following the same playbook today: acting quickly and emphatically to stave off broader contagion fears by backstopping major financial institutions.

An important distinction between then and now, is that most banks, especially large national banks, remain well capitalized due to tighter regulations in a post-GFC world. Silicon Valley Bank was in a “unique” situation due to the make up of its depositor base, asset base, and customer base. Critically, 86% of deposits were above FDIC insurance limits whereas most banks are closer to 50%. Combined with poor asset management, which loaded their asset portfolio with long-dated Treasuries whose value fell significantly with higher rates, and a slowdown in business from a concentrated customer base, the stage was well set for a bank run. While other banks, such as Signature Bank and First Republic face similar issues, most major banks are in much better financial condition.

Current Environment

Just last Wednesday, investors were pricing in expectations of higher rates as Fed Chair Jerome Powell delivered a hawkish message to Congress. In his remarks, Powell left the door open for a 50 basis point hike in March and a potential increase in the Fed’s 2023 median target. Markets quickly reacted to his comments, pricing in a total of four to five 25 basis point hikes by July. On Friday, these expectations started shifting, and now markets have priced in just one, 25 basis point hike in March and then a pause until July, when markets expect the Fed to cut rates. These movements help illustrate the rapidly changing environment, and the yield curves below show the speed and magnitude of the moves.

Source: Treasury.gov as of 3/13/2023

Investment Implications

Despite regulatory efforts made over the last decade to improve the strength of financial institutions, cracks still existed, but were overlooked in an ultra-low-rate environment. Historically, when rates have risen, things tended to break. We don’t always know where or how the next crisis will occur, which is why we believe it is important to maintain a diversified portfolio that can better withstand shocks such as a major bank collapsing.

As long-term investors, it is important to look through the short-term noise and volatility. While it is tempting to sell now, timing the market is a notoriously difficult endeavor, as it requires knowing when to get out and when to get back in. On September 25^th, 2008, Washington Mutual Bank collapsed, which remains the largest bank failure in history. While the next several years were very painful for equity investors, a hypothetical, globally diversified portfolio of stocks and bonds would have still had positive returns:

Source: Morningstar as of 3/13/2023; see disclosures for important information

While markets continue to fluctuate, and newly released inflation data further complicates the Fed’s potential actions next week, U.S. equity markets appear to have stabilized for the time being as the S&P 500 Index finished Monday just 0.15% lower, which further emphasizes the strategy to stay calm and stick to long-term investment plans. As always, we continue to monitor the situation closely.

DISCLOSURES

The post Silicon Valley Bank – A Not So Broken Record appeared first on Moneta Group.

source https://monetagroup.com/blog/silicon-valley-bank-a-not-so-broken-record/

Wednesday, March 8, 2023

Not So Fast

Aoifinn Devitt – Chief Investment Officer

Markets meandered somewhat aimlessly over the past week with the now familiar mix of resilient “hard” economic data and waning consumer sentiment. And it is clear that Chairman Powell is not liking what he is seeing. This week, he continued what has almost become an “apology tour” for the last 25 bps rate rise – and suggested that the Fed might well look to increase rates beyond what markets currently expect. In his testimony before the Senate Banking Committee, he forecast that inflation’s long road to 2% would be a bumpy one with the destination far from sight, and this poured a dose of cold water on markets.

The evidence of inflation is, as ever this year, frustratingly bumpy itself. The purchasing managers index is showing renewed price support, and this, combined with a robust consumer suggests that inflation could remain elevated for some time. On the other hand, forecasts are for commodity prices to weaken and the fact that the mild winter is now coming to an end suggests that that component may at least be no longer as relevant. Supply chain problems are as good as resolved too, suggesting that any dislocations that these created will be “transitory”, and last week we noted the slackening of the cost of “shelter”.

Recent market performance was dented by the reaction to Chairman Powell’s testimony, but overall, the last week has been somewhat positive:

Source: Morningstar as of 3/6/2023

The verdict is in on 4Q earnings. In the S&P 500, they declined on average 4.9% over the same quarter last year, marking the first quarterly decline since the third quarter of 2020. While large tech names attracted some attention for the sizeable drops in earnings they turned in, energy bucked the trend showing earnings growth of over 50% in the 4^th quarter – leading all 11 sectors.

Although news of layoffs continue to pepper the financial press – the latest being from Meta – there is persistent evidence that corporations themselves continue to be in rude health. The spread of US investment grade credit is at record low relative to 6-month T bills, suggesting that default risk is perceived as low and that credit investors are secure in assessing corporates creditworthiness. This would square with the backdrop that differentiates the current economic backdrop from the Great Financial Crisis. Corporates simply are not as over-extended as they were then – leverage levels are lower and overall risk-taking has been far more subdued than in the run-up to 2008. This might explain why defaults just have not materialized in the current economic climate. Of course, ever-higher interest rates might start to choke off sources of lending, although maybe corporate treasurers have learned to term out their debt, have locked it in at lower rates, and have learned to work with their lending partners. As the recent spate of press releases show, companies (particularly retailers) are learning that it is prudent to be prudent – to be cautious and manage expectations down. So, can the investor believe everything they hear? Or do they need to read between the lines? It is likely that we will have much practice in doing this in the murky months ahead. We will embrace the challenge.

© 2023 Advisory services offered by Moneta Group Investment Advisors, LLC, (“MGIA”) an investment adviser registered with the Securities and Exchange Commission (“SEC”). MGIA is a wholly owned subsidiary of Moneta Group, LLC. Registration as an investment advisor does not imply a certain level of skill or training. The information contained herein is for informational purposes only, is not intended to be comprehensive or exclusive, and is based on materials deemed reliable, but the accuracy of which has not been verified. Trademarks and copyrights of materials referenced herein are the property of their respective owners. Index returns reflect total return, assuming reinvestment of dividends and interest. The returns do not reflect the effect of taxes and/or fees that an investor would incur. Examples contained herein are for illustrative purposes only based on generic assumptions. Given the dynamic nature of the subject matter and the environment in which this communication was written, the information contained herein is subject to change. This is not an offer to sell or buy securities, nor does it represent any specific recommendation. You should consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. An index is an unmanaged portfolio of specified securities and does not reflect any initial or ongoing expenses nor can it be invested in directly. Past performance is not indicative of future returns. All investments are subject to a risk of loss. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. These materials do not take into consideration your personal circumstances, financial or otherwise.

The post Not So Fast appeared first on Moneta Group.

source https://monetagroup.com/blog/not-so-fast/

Wednesday, March 1, 2023

The Other Side of the “Pause”: Market Returns When the Fed Stops Hiking

Chris Kamykowski, CFA®, CFP® – Head of Investment Strategy & Research

Markets are flummoxed with changing expectations for how long the Fed will raise rates and for how long they hold at the eventual terminal rate. Market expectations at the beginning of the year largely coalesced around two 0.25% rate hikes before a Fed pause and then potential rate cut by the end of the year or early 2024. Recent economic data has put a wrench into those expectations as inflation has proved more resilient while trending lower, the labor market continues to be hot, and the economy may be side-stepping a recession in early 2023. Furthermore, the Fed has continued with its efforts to warn, advise, and guide the markets on the combination of factors in its framework for deciding on when to initiate a pause: namely, meaningful and persistent declines in the rate of inflation toward their 2% long-term target and weaker employment levels. Getting there may risk economic pain (e.g., recession) but as the Fed has noted time-and-time again, getting ahead of inflation now and taking whatever medicine is required, will be less onerous than what is needed if inflation rises and, importantly, inflation expectations become unanchored.

That all said, markets continue to hope for this somewhat “mythical” pause in rate hikes, which leads to two important questions: historically, how have US equity and investment grade fixed income returns behaved after the Fed has officially hit its terminal Fed funds rate? Additionally , while no two tightening cycles are the same, are there inferences we can make on the potential path for US equity and fixed income markets once the Fed pauses their current tightening cycle?

For historical reference, since 1988, there have been seven distinct interest rate hiking cycles, including the current one that commenced in March 2022. On average, the Fed funds rates has been hiked by 275 bps in each tightening period over an average of approximately 16 months. This current tightening cycle has been historically swift with the Fed funds rate moving 450 bps over 12 months and looks to continue.

Source: Federal Reserve

The two tables that follow highlight returns during, six months after and one year after the Fed concludes its hiking cycle (“pause)”. Over the previous six rate hike cycles, equity market performance during the rate hike cycles has, on average, been distinctly positive, although the most recent cycle has been definitively negative since its start. However, returns six- and 12-months after the Fed ends its rate hikes have been clearly positive on average, ranging from +15%-24%. The one time period that witnessed negative returns on the heels of the pause in rate hikes, was the 1999-2000 hiking cycle. This was driven largely by the immense deflating of the tech bubble of the early 2000s.

Source: Morningstar as of 2/28/2023. Equity cumulative returns calculated using S&P 500 Index return. See further disclosures at end of document. ^One hike of 25 bps. Federal Reserve paused immediately following single hike. *Hiking cycle has not concluded.

What may be a surprise to investors is how the fixed income market has done through these periods, given rising rates typically drive bond prices lower. While average returns during the hiking cycles have been subdued to outright negative, the average return for bonds after the final rate hike has been 7% and 12% for the subsequent six- and 12-month periods, respectively. The benefit of higher yields is higher yields, which can provide a less volatile interest rate environment and more stable return profile as the market transitions to a less hawkish Fed.

Source: Morningstar as of 2/28/2023. Fixed income cumulative returns calculated using Bloomberg US Aggregate Index Returns. See further disclosures at end of document. ^One hike of 25 bps. Federal Reserve paused immediately following single hike. *Hiking cycle has not concluded.

There are clear reasons for the current consternation in the markets and why a single increase in the expected number of rate hikes has caused recent drawdowns in the market: impatience for the Fed letting off the brakes and added uncertainty as to when this “pause” will commence. The market loathes uncertainty and reacts accordingly. However, as has been shown, markets have performed well on the other side of the termination of a Fed hiking cycle; it may be no wonder why investors are impatient to see rate hikes finish. That said, as has been noted many times, investors should continue to use their own investment objectives, risk tolerances, and liquidity needs to dictate their appropriate long-term investment allocation while avoiding changes due to the uncertainty of the Fed’s decisions. Maintain a portfolio that is properly diversified to weather the volatility and uncertainty that the market will undoubtedly experience throughout each year.

Sources:

Morningstar

Federal Reserve

Definitions:

The S&P 500 Index is a free-float capitalization-weighted index of the prices of approximately 500 large-cap common stocks actively traded in the United States.

The Bloomberg US Aggregate index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.

Disclaimer

The post The Other Side of the “Pause”: Market Returns When the Fed Stops Hiking appeared first on Moneta Group.

source https://monetagroup.com/blog/the-other-side-of-the-pause-market-returns-when-the-fed-stops-hiking/

A Bruising Tussle and Buyback Blowback

Aoifinn Devitt – Chief Investment Officer

It was a bruising week last week as the S&P recorded its third negative week in a row and its largest weekly decline in over 10 weeks. The tripwire in this case was the cautious sales outlooks from two major retailers – Walmart and Home Depot, which sent both bonds and stocks tumbling.

As the chart below shows, the month of February was a down month for the S&P as well as the Nasdaq, although both remain up for the year.

Source: Morningstar as of 2/28/2023

Meanwhile, the hard data continues to be mixed. The Personal Consumption Expenditures Price Index, which is the US Fed’s preferred gauge for measuring inflation rose more than expected – 0.6% from December to January, a month-to-month increase not seen since June of last year.

Housing indicators showed existing home sales continuing to trend lower, although by less than in the previous 12 months. There was also evidence that newly built apartments coming online has led to a drop in rents.1 The current delivery of new supply is estimated to be the largest increase since 1986. This either indicates a consumer that is maxed out in terms of spending or a massive supply/demand mismatch. Both of these are weakly positive indicators of a consumer that may be running out of steam, and may ultimately be positive for inflation numbers as “shelter” was taking up an increasing share.

For now, though, the message – loud and clear – seems to be that markets may have got ahead of themselves in trying to put a lid on inflation worries. We are not, by any means, out of these woods.

This pattern was repeated in Europe, where both Spain and France showed inflation rebounding, suggesting that the European Central Bank would have to press ahead with its tightening agenda.

The indications that central banks and monetary policy tightening have further to go had a profound effect on bonds over the past week with rising yields across the board. Currently, bonds have essentially “round tripped” or have given up almost all of their gains since the beginning of the year. All eyes will be on February’s employment data, due to be released over coming days for an indication of the future direction of interest rate policy.

Meanwhile, another tussle was brewing relating to stock buybacks. While stock buybacks have year to date reached a record of over $200 bn and they are expected to top $1 trillion this year, the practice had come under assault by the President during the State of the Union speech. It seems, to date though, that few companies have been deterred by the new 1% federal tax on buybacks that took effect at the beginning of the year. Warren Buffett in the past week waded into the fray defending the practice. Buybacks – or companies repurchasing their own shares to return money to shareholders – are generally seen as a positive action by the company and have bolstered stock market strength, even in the wake of other stock market counterforces. It will be interesting to see what will happen to sentiment if this prop is removed.

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