I hope you are having a wonderful summer and are staying cool in this record setting heat wave we are seeing. Before we dig into the markets and the economy, I wanted to let you know that this will be the last of the written email monthly newsletters. We are going to start producing a biweekly video podcast for our clients. The focus of this podcast will be on the most current retirement topics such as taxes, new legislation, as well as commentary on the markets, the Fed, and the economy. We feel that more clients will stay engaged with a short video podcast than a monthly written email. Our goal is to produce two, 20-minute video podcast episodes per month. These will still be delivered to your email inbox, just in a video format. One of our main goals as a firm is to improve our communication with our current clients. We feel this video podcast will be an excellent medium to communicate the most current information to you in a timely fashion. If you have any ideas or topics for an upcoming episode, please feel free to pass those along and we will do our best to incorporate them into an upcoming episode. From all of us here at ClearPath Financial and Insurance Solutions, LLC., we truly hope you enjoy the last few remaining weeks of summer. I feel August is going to be a wild and crazy month for the markets with a lot of crucial data coming out in the next couple of weeks. Stay safe, have fun and God bless!
Here is what we are covering in the August newsletter:
- Bear Market Bounce - Market Updates
- What the analysts are saying – Quad update
- Tax minimization using Roth Conversions
Bear Market Bounces – Market Updates
I thought this cartoon from Hedgeye Risk Management was very appropriate as we enter August. While the markets got crushed again in June (-8% S&P 500), July was a different story altogether with markets ripping upwards (+9.1% S&P 500, +10.55% Nasdaq). Most of the upward moves came at the very end of July, as the market perceived Jerome Powell’s latest comments as dovish (i.e., rate cuts coming soon in 2023). We completely disagree with a lot of so called “experts” that the Fed is going to end Quantitative Tightening and stop interest rate hikes. The main reason for our disagreement is high, sticky inflation or should we say “stagflation.” Inflation has proven rather sticky despite several rate hikes as CORE CPE went to 4.8% which is the highest in 41 years. The Fed’s main duty is to keep inflation under control and their two main weapons are raising interest rates (slow down borrowing/demand) and Quantitative Tightening (taking liquidity out of the equity markets). It is important to note that real Quantitative Tightening has barely begun, but the Fed will get more aggressive with selling off its balance sheet starting in August. While most pundits are focused on interest rate hikes, we feel QT will have more of an impact on the markets. Will the Bulls win the second half of 2022 with the markets finishing in the green for the 14th consecutive year or will the Bears finally have their year? Time will tell and the markets always get it right over the long run.
Our analysts just released this chart (see below). I think it is one of THE most important charts to study as we are coming off an extremely positive bear market bounce in July and Fear of Missing Out (FOMO) becomes contagious.
The chart above is comparing the Dotcom crash of 2000-2003 and the Global Financial Crisis of 2007-2009 to the “All Bubble” crash of 2022. The main thing I want to draw your attention to are the multiple bear market bounces that occurred in each crash. After a -26% drawdown about halfway through the Dotcom crash, the markets rallied +21% immediately afterwards as every expert on TV was claiming the bottom was in. Then, the bottom fell out and the market crashed -32%. Then it immediately rallied and went up +21% again as the pundits swore the bottom was in this time because everything was a great value. “Buy stocks” they screamed. Too bad, the market went down another -19% finally making the final low for the cycle. A similar bounce happened in 2008 when markets went ballistic (+23%) only to give it all back and then some with a -28% drawdown to finish off the financial crisis. But, but, but…It’s different this time. Wrong! Take a look at the double digit bounces we’ve had after each crash in 2022. Every time the market has rebounded and the Jim Cramer folks on CNBC are proclaiming the bottom is in, economic gravity sets back in, crushing false narratives and story tellers (i.e., Bitcoin) as the market eventually makes a new lower low. While no one can predict what the markets are going to do on a day-to-day basis or even a month-to-month basis, stocks cannot escape the laws of economic gravity. It all boils down to simple math, two quarters in a row with negative GDP growth = RECESSION. And while the White House wants to rewrite the economic textbooks on what a recession is, the markets won’t care. Just like you and I can’t escape the laws of gravity here on Earth, stocks will not be able BS their way out of the economic gravity that will eventually overwhelm them in the end. One of the best indicators of an impending recession is the yield curve. The 10s/2s yield curve is completely inverted at -29 BPS. Anytime the yield curve inverts, it is one of the single BEST indicators that a recession is imminent.
We continue with our thesis that the bottom won’t be in until:
- Inflation stays under 5%
- A lot of Americans are unemployed
- Most “zombie” companies go belly up (those without any positive cash flow)
- A lot of these crypto $#@!coins get blown up and their founders arrested for fraud
- The Fed really pivots and starts Quantitative Easing and Rate Cuts
Here is a look at what the markets did in July:
I love this Heat Map from finviz.com that shows the S&P 500 performance for July on one graphic:
Here is a look at the different asset classes and how they did in July:
And lastly, the performance year-to-date:
Analysts Updates – Welcome to August
The analysts at Hedgeye Risk Management have updated their GIP (Growth Inflation Policy) model. Not a lot has changed except that 3Q22E (third quarter expected) is a fair fight between Quad 1 and Quad 4. What’s more important, because the markets are always forward looking, is the position change of 4Q22E. It has moved into a deeper position well within Quad 4. The latest probability of a Quad 4 setup for the 3rd and 4th Quarter has increased. That is definitely not bullish for the markets.
© Hedgeye Risk Management, August 2nd, 2022
Even after the nice bear market bounce in July, we continue to tread very cautiously with our portfolio models as the data implies that more pain is on the way. Our biggest positions remain long US Dollar (USDU), Anti Beta (BTAL) and tail risk (TAIL). We will continue to carve out a large position in cash that will be used a “dry powder” reservoir to buy the dip when we eventually come out of Quad 4 in the future. As yields start to come down on the long end of the curve, we are starting to take minimal positions in certain bond ETFs such as IEF (7-10 year US Treasury) and BNDX (Vanguard’s international bond fund). The signals for the long end of the curve for bonds recently turned bullish.
Tax Minimization using Roth Conversions
As we head into the fall, we will start to have conversations with most of you regarding a Roth Conversion for 2022. For most of our clients with substantial amounts of pretax funds (IRA), doing incremental Roth Conversions over the next four years can potentially save you significantly on your Federal tax liability over your lifetime. We will start scheduling virtual meetings with you to discuss whether a Roth Conversion is a good idea or not. Doing a Roth Conversion during a market crash can be beneficial if you have dry powder, i.e., cash sitting in your IRA account that hasn’t been crushed by the market selloff. This is one of the reasons we have a large position allocated to cash in our portfolio models (and have had since February). It is generally frowned upon by the tax experts to sell equities that are down double digits and move the proceeds (cash) to a Roth IRA only to buy back into different stocks/funds. You will not only be locking in a loss on the market side, but also taking a hit on the tax side as well. This double whammy is much harder to overcome. It is a better strategy to have cash that is sitting on the sidelines and convert that over to the Roth IRA, pay your taxes and then buy back into the stock market when the signals are confirming that the bottom is truly in and we are heading into a Quad 1 or Quad 2 market setup. Buying the dip with this dry powder can be a powerful method to grow your Roth IRA and overcome the taxation much quicker utilizing a rebound in the stock markets. Hopefully, the markets will present this opportunity as we head into the fall or winter. FYI, Roth Conversions must be completed by December 31st of each calendar year.
Thank You for Trusting Us
From all of us here at ClearPath Financial, we are humbled by your faith and trust in us. While we are not perfect, we are continuously trying to getter better in all facets of our business. Excellence is truly a standard we are reaching for. Have an awesome August. As always, if you need anything, please don’t hesitate to reach out to us.
Matthew P. Sherman
Investment Adviser Representative
ClearPath Financial, LLC., Partner of Abraham and Co. Inc.
Chief Investment Officer