Financial Markets and the Economy
Stock markets pulled back in the first quarter of 2022. In the U.S., the S&P 500 was down -4.6% in the first quarter while globally, the MSCI EAFE was down -6.3%. Small company indexes trailed larger companies and the Russell 2000 was down -7.5% for the quarter. Treasury yields rose but were still fairly low as the 10-year U.S. treasury bond was yielding 1.7% at the end of March. While still low from historical averages, rising interest rate expectations dealt a decline to bond indexes in the 5 to 8% range.
In the first quarter markets started to react to rising interest rates after recent all-time highs for stocks last year and short-term bond yields that were near zero. In our year end 2021 commentary we wrote about the prospect of higher interest rates and how markets generally would need to adjust to the outlook of future interest rate rises. To give some historical perspective, interest rates have declined for nearly 40 years. When the global economy shut down in 2020 due to a pandemic, the Federal Reserve used its power to manipulate rates to nearly zero. At the same time, sovereign governments, and the Federal Reserve both injected money into consumers accounts and businesses to prevent a financial collapse. While most would agree this was warranted, the economy bounced back much faster than expected. As any of us who can recall Econ 101, too much money chasing too few goods leads to rising prices, i.e., inflation. Generally, small rates of inflation are considered normal for a healthy economy, but the price rises we are experiencing now can lead to a price-wage spiral that is hard to contain. The last time this happened was in the 1970s.
The Federal Reserve has now reversed its course and has moved to a determined inflation fighting mode. The new fed funds rate target is now 2 to 3 % by year end from its recent zero. In other recent periods of inflation, when the Federal Reserve moved to tamp it down, the fed funds rate was raised to 5 or 6 %, and to fight the runaway 1970s wage-price spiral the fed funds rate peaked at 19%. We have already seen the effects of the first rate rises. Mortgage rates, money market rates, car loans, starting or running a business, and all manner of borrowing costs are rising. Workers are demanding higher wages to offset increasing grocery, gas, and energy bills. The Federal Reserve will raise rates to slow the economy, but it is considered a slow and blunt instrument to affect a policy to achieve lower inflation rates. In fact, historically, the Federal Reserve policy to slow inflation has nearly always resulted in a recession. If past is prologue, we will be reading and hearing about, hoping for a soft landing, possible stagflation, and maybe a recession before inflation subsides to a desired level.
The growing consensus among forecasters is that after 40 years of declining interest rates, and accommodative monetary and fiscal policy, that we are starting a period of historically closer to average fixed income and stock returns. We believe our families are positioned properly for this outlook. Generally, we have been positioned in fixed income to benefit from rising rates, and recent performance confirms that. Longer term stocks should do well but possibly less than the returns seen over the last 10 years which were well above long term averages. We look forward to discussing your planning and investment goals.
With all the negative news in the world today, we wanted to focus on charitable giving, which is an area of planning that we find gratifying. There are many advanced planning strategies and techniques that can be used related to charitable planning, but in this letter, we’re focusing on one that is simple yet highly effective. If you already have this part of your planning covered this will just be a reminder, and if you don’t, we should discuss in our next review!
The technique involves using a donor advised fund to facilitate charitable gifts. Donor advised funds are simply charitable accounts that can be opened through Schwab, Fidelity, or countless other custodians. These accounts can be funded by contributing appreciated securities that would otherwise incur capital gains taxes if sold. Once deposited, those investments are sold, allowing you to direct a gift from the account directly to the charity of your choice. To the extent that the proceeds from the contribution aren’t going to be distributed right away, they can be invested in the account for future growth.
There are two primary advantages to using a donor advised fund. The first is that it allows you to avoid paying capital gains taxes on highly appreciated investments. For example, assuming you purchased a position for $10,000 and it has grown to $100,000. If you sell that position you would have to pay capital gains tax on the $90,000 gain, which could cost from $13,000 to over $35,000 (depending on your other income and what state you live in). If you donate this same stock position to your donor advised fund, you will receive a charitable deduction equal to full value of the investment ($100,000) in addition to avoiding the capital gains tax.
The second primary advantage to using a donor advised fund is that it allows you to separate the timing of when you receive the tax deduction from when you give the money away. For example, if you were to have a liquidity event or have higher than normal compensation in a certain year, you may find yourself in a higher tax bracket and it could make sense to “front load” future years of charitable giving with a larger donation in that year. In subsequent years when you are in a lower tax bracket and would benefit less from the donation, you can simply gift out of the account. The bottom line is that if you have appreciated securities in a taxable account, please think twice (and call us) before you give cash or write a check to a charitable organization!
Please do not hesitate to reach out as you have questions or concerns related to your portfolio, planning, or anything else.
Waypoint Capital Advisors