TURNING 50

It’s catch-up time! People 50 and older can contribute $6,500 more to their 401(k)s or 403(b)s each year, for a total contribution of up to $26,000 this year. Those 50 and older who contribute to IRAs and Roth IRAs can throw in an additional $1,000, for a total maximum annual contribution of $7,000.

TURNING 55

Normally people have to pay a 10% federal penalty, along with income taxes, when they withdraw money from retirement accounts before age 59 ½. The penalty (but not the taxes) disappears on 401(k) and 403(b) withdrawals if you’re 55 or older when you quit, get fired or retire. This “separated from service ” rule applies during or after the year you turn 55.

TURNING 59 ½

At this age you can take withdrawals from workplace plans or IRAs without penalty. Also, some 401(k) plans allow workers who are at least 59 ½ to do an “in-service ” rollover, allowing you to move money into an IRA while still working and contributing to the 401(k). If you’re interested, check with your 401(k) plan provider or your human resources department to see if this option is available to you.

TURNING 60

For most widows and widowers, age 60 is the earliest that they can begin Social Security survivor benefits. (Survivor benefits are available starting at age 50 for survivors living with a disability, or at any age if the survivor cares for the deceased spouse’s children who are under age 16 or disabled.)

TURNING 62

This is the earliest age you can begin Social Security retirement or spousal benefits, but your checks will be permanently reduced if you start before your full retirement age, which ranges from 66 to 67. Also, you’ll face an earnings test that reduces your benefit by $1 for every $2 you earn over a certain amount, which in 2021 is $18,960. The earnings test disappears once you reach full retirement age.

TURNING 65

At 65, most Americans are eligible for Medicare, the government health care program. Typically, you’ll want to sign up in the seven months around your birthday — meaning the three months before the month you turn 65, the month you turn 65, and the three months after. Delaying after that point can cause you to pay permanently increased premiums. Explaining the ins and outs of Medicare is beyond the scope of this column, but you can learn more at medicare.gov or by calling Medicare at 1-800-MEDICARE (1-800-633-4227) to request the “Medicare and You” handbook.

TURNING 66 to 67

Full retirement age is 66 for people born between 1943 and 1954. The age rises two months for each birth year after that until it reaches 67 for people born in 1960 and later. Waiting at least until full retirement age to start Social Security benefits means you won’t have to settle for checks that have been reduced because you started early or because of earned income.

TURNING 70

A juicy benefit awaits those who can delay the start of Social Security after full retirement age: Their benefit increases by 8% annually until it maxes out at age 70. This not only means more money for the rest of your life, but if you’re the larger earner in a couple, it also maximizes the survivor benefit for your spouse.

TURNING 72

Most retirement plan contributions reduce your taxes in the year you make them, and your account grows tax-deferred over the years. But eventually the government wants its cut.

You’re required to start taking at least a minimum amount from most retirement plans beginning at age 72. (Required minimum distributions used to start at age 70 ½, but that’s been pushed back.) There are a couple of exceptions. If you continue to work, you can wait until you retire to start minimum distributions from your 401(k) or 403(b). Minimum distributions are still required from traditional IRAs even if you’re working.

If you have a Roth IRA, however, you won’t be required to start distributions at any age. If you leave the money to your heirs, however, they will have to start taking withdrawals.

 

US Economy

 

  • Household incomes surged in March, driven by government checks.
  • Spending increased sharply, and is now above pre-COVID levels.
  • Saving has been extremely high.
  • Wages are now above pre-COVID levels
  • Sustained gains in wage costs could boost inflation.
  • Wages in low-skill occupations are rebounding from the pandemic-related slump.
  • The updated April U. Michigan consumer sentiment index was even stronger than the prior report.
  • The Chicago PMI index hit a multi-decade high, pointing to remarkable strength in the manufacturing sector.
  • The April ISM Manufacturing PMI unexpectedly pulled back from the highs. While factory activity remains exceptionally strong, there are signs that supply-chain bottlenecks are becoming a drag on production and employment.
  • Economists expect the situation to ease in the months ahead.
  • Base effects in the core PCE inflation will reverse in 2022.
  • Price gains in the overall economy (GDP deflator) have been outpacing consumer inflation.
  • Residential and non-residential construction spending trends continue to diverge.
  • Public construction spending has slowed.
  • US automobile sales hit the highest level in years.
  • The jobs recovery has been lagging the economic rebound.
  • Job openings on Indeed keep climbing.

 

The Fed Put

 

The Fed Put is the expectation that the US Federal Reserve Bank will always come to the rescue of any stock market drop of 20%+ and inject trillions in capital to pull the stock market back to an upward trajectory.  No more bear markets!!!

Everything related to investing we know today could be useless in the future. Many historical financial relationships are now broken, perhaps permanently. Your hard-won investing and financial knowledge may already be useless, resulting in the end of investing as we know it.

Wow – that really is a provocative statement, isn’t it? Nevertheless, this investing veteran, with 35 years of experience in the markets, believes it’s true.

With the situation that’s set up now, investing in equities could become like buying shares of Bitcoin—that is, the price paid is 100% dependent on the forces of supply and demand—not based on assets backing the investment vehicle, a discount of dividends/earnings/future flows of cash, or any true inherent value.

In the future, will participants no longer consider an investment’s economic fundamentals because they have become meaningless? That is no longer investing; it is pure speculation with hopes on the “greater fool theory”. This isn’t my imagination creating a worst-case scenario in a dystopian future—it’s happening today for a significant portion of publicly traded companies—even 10 months after the massive infusion occurred. It could take a while for all that money to work through the system. However, the Fed has now set a precedent and there will be nothing stopping it from doing it again during the next significant economic contraction. The bear markets that normally accompany severe recessions may be a thing of the past.

We are living at a time when up is down, left is right, and reality has been turned inside-out. Last year—2020—nearly every aspect of investing you can name became inverted, as you will see in this series. When will things return to normal? Who can say—perhaps never if the Fed continues to manipulate market prices.

Let’s try an old-school thought experiment…

Consider: All else being equal and with no further information available, would you choose to put your money in a stock with a Price/Earnings (PE) Ratio of 8 or one with a PE ratio of 38?

The seemingly obvious answer is that we would choose the stock with the lower PE ratio, which means it is relatively cheaper. That is, the cost to buy a dollar of earnings using shares that have a PE of 8 is less than the cost to buy a dollar of earnings using shares with a PE ratio of 38. If both companies have a profit-per-share of $5, the cost of each stock is $40 and $190, respectively.

However, 2020 turned that logic upside down. The more expensive 38-PE stock was purchased most frequently by investors, resulting in already high prices shooting even higher and PE ratios becoming even more outrageously high. This trading approach is how you get Tesla at a PE ratio of 1,711.21 or Ceva, Inc. (CEVA) at a PE ratio of 47,069.

Many indicators used by modern investment strategists—institutional money managers, hedge fund managers, newsletter writers, and well-informed individual investors—have been used reliably for more than 70 years. But in 2020, the relationship between share prices and those indicators were BROKEN—and not without good reason.

First, let’s understand the foundations of modern investment thinking. This conversation has to begin with EMH, an idea proposed a half-century ago.  Eugene Fama introduced the Efficient Market Hypothesis (EMH) in the May 1970 issue of the Journal of Finance. EMH posits that everything that can be known about a publicly traded stock (or Index/ETF, or any other publicly traded security) is public knowledge. Because public corporations must publish all available company-related information, and investors have access to all other info that may affect the stock, the playing field is equal for everyone.

If the guy next door has all the same information you have, how could you ever consistently beat him? Extending that logic, EMH says it’s impossible to beat ‘the market’ because the market is made up of all your worldwide investing ‘neighbors,’ who are all equally armed with the same information.

Even inside information available to corporate executives is factored into the stock price, the theory says, discounting future positive or adverse developments. EMH states that trying to beat the market is a fool’s game. But every year, tens of millions of investors/traders try to do it, perhaps because they inherently know that the market is not truly efficient.

The Efficient Market Hypothesis has remained a generally accepted blueprint for equity markets required for several generations of MBAs since the 1970s. Since then, the EMH has been supplemented with 3-5 exceptions (depending on which university’s advocates you are talking to) that historically allowed investors to beat the market, with Eugene Fama being one of the first reviewers to identify an exception to his own earlier rule of efficient markets. Fama famously teamed with Kenneth French to first identified ‘value’ as being an exception to the rule of efficient markets. Then the exceptions gradually increased.

Initially, the exceptions consisted of small-capitalization vs. large-capitalization stocks and high-value (high book-to-market) vs. low-value (low book-to-market) stocks as factors that beat the broad market over the long-term. The definition of a ‘value stock’ hints at the concept’s age since Book Value has not been a meaningful variable in stock investing for 25 years or more.

Dozens of examples of exceptions to the rule have been pointed out to the EMH advocates, but the academics invariably disregard the examples of successful investors such as Warren Buffett. The ‘Oracle of Omaha’ has directly addressed the absurdity of EMH, and as proof, he wielded his consistent trouncing of the market during 60+ years of investing and building an empire worth $600 billion, much to the EMH academics’ chagrin.

And what do they make of a data-focused, empirically driven outfit like Warren Buffet or computer models like the ones we use which have done well for 21 years? Their silence about Buffett, and a dozen other examples speaks volumes.

So far, the slow-moving academic behemoth behind EMH has only discovered 3-5 factors that produce exceptions to the rule of always-efficient markets. However, our research has found dozens of useful indicators quietly hiding in the Factor Zoo. This number increases when we include Composites of Uncorrelated Indicators—the real competitive advantage wielded by trend following computer models in the investment world.

The current academically accepted factors that provide exceptions to EMH include Size, High Quality, High Value, High Momentum, and Low Volatility. Business-school academic literature has endlessly tapped these factors as a source for research since it was ‘discovered’ that there are exceptions to the Efficient Market Hypothesis.

However, we know that all this nonsense about efficient markets is absurd. Whenever there is human interaction in a financial transaction, there is an opportunity to identify—and frequently exploit—human behavioral errors. There are dozens of behavioral weaknesses, particularly in matters dealing with money, that has been well documented by psychologists and economists. These ‘exceptions’ that outperform the market have proven to be consistent and dependable—until 2020.

Four of the five main EMH exception factors were turned upside down in 2020, graphically demonstrating the strangeness of the year. Typically, several of these factors would outperform the market in any year, but in 2020, Momentum beat all the factors.

Remember, the Momentum factor assesses only stock price increases. No substance measures that would garner a prudent investor’s attention are involved in the Momentum factor. Yet Momentum is the only factor that dominated and beat the market in 2020. Will it be the factor that excels from now forward? Perhaps.

One additional thing to notice is that while Momentum outperformed all other factors and the market, it was also the most volatile factor. When there was a dip in momentum, it fell farther and faster than anything else. There are no free lunches—with the exception of the free lunch you get from using carefully crafted quantitative strategies that employ uncorrelated ETFs to achieve a high Risk-Adjusted Return (RAR), like we do with our Tactical ETF strategy.

In March 2020, the US Federal Reserve’s actions broke many steadfast, balanced financial relationships that always supported the discipline of investing. As you know, March 2020 is when the US got walloped by the Covid Pandemic, businesses shut down, citizens locked down, and the US entered a severe recession—the worst by many measures since the Great Depression. A nascent recession was already getting underway in the US in mid-February, then the Covid-19 Pandemic began, accelerating and exacerbating that recession into something far worse than what would have occurred without the pandemic.

Recessions have historically caused significant—if temporary—declines in US stock prices, with the average bear market lasting 14 months.  The so-called ‘bear market’ that began in late February 2020—if it even was a ‘bear market’—was the fastest in history, extending only 23 days from its pre-selloff high on February 19 to the March 23 low, when an epic rally began. That rally is one of the most robust and fastest on record, recovering the -34% Feb-March loss in about 8.5 months and gained 67% by the end of 2020.

Yet, the recession that began in March 2020 continues today, with 900,000 filing for first-time unemployment benefits last week, and S&P 500 Profits continuing to decline. These circumstances normally would have kept stock prices subdued for all of 2020 through today and beyond. Recall that during the market meltdown accompanying the 2007-2009 Financial Crisis, the S&P 500 required until April 2013—5.5 years—to recover to its prior high, set on Oct. 9, 2007.

Having been both an investor and an investment professional for the last 35 years and experiencing seven ‘official’ recessions, I can assure you that the market crash of 2020 felt nothing like a typical bear market. As we experience them in real-time, bear markets have historically been long, relentless, punishing declines of stock prices that pummel investors endlessly, testing every aspect of internal strength that our character can muster.

An alternative to riding out bear markets is that you can use a proven quantitative investment strategy that will rotate out of Equity ETFs into Fixed Income, Inverse or other Defensive ETFs at the appropriate time and forget about watching and stressing about the market.  That is our choice.

So, what caused last March’s -34% selloff to vanish quickly and the market to rebound back to its prior high level so quickly—in just five months? The obvious answer is that the Federal Reserve plowed more than $3 trillion into the financial system, announced last March and implemented over the next two months. The stock market sat up and noticed that day—it reversed course—and the price of the S&P 500 index has been climbing ever since.

On February 26, the US Federal Reserve Balance Sheet stood at $4.185 trillion following a steady decline that began in 2015. Then, as the market selloff accelerated in March, the Federal Reserve decided it had to act, and in March last year, it brought out the “helicopter money” made famous in a paper by former Fed Chairman Ben Bernanke.

Bernanke talked about it, but current Fed Chairman Jerome Powell made it happen. The Fed Balance Sheet spiked sharply higher to $7.165 trillion by June 3. And since mid-year 2020, the Fed has added about $15 to $20 billion of Treasuries purchased per week to its asset total. All this money-creation left the Fed with a balance sheet totaling $7.36 trillion by year’s end, 2020.

The Federal Reserve’s aggressive actions infused enormous liquidity into the banking system, and those banks were forced to push that money into the economy and investment assets, creating sharply increased demand for stocks that overwhelmed the negative recessionary factors, which in the past have accurately signaled declining share prices.

However, with $TRILLIONS of ‘free’ money poured into the US economy and banking system, all those supply-side factors, which were signaling a high risk for stock declines during an economic recession, were muted. The newly muscled economic demand outstripped the opposing force of supply, and stock prices skyrocketed higher.

The Federal Reserve’s balance sheet nearly doubled in just ten weeks, beginning in late-March 2020.

Remember the quantity of money we are talking about here. An easy rule of thumb is that the Fed’s Balance Sheet is now the equivalent of $1,000 for every human alive on earth today—more than 7 billion souls. Moreover, just like the world population, the Federal Reserve’s balance sheet is still growing every day.

Last March, the Federal Reserve pushed trillions of dollars of liquid assets into financial institutions, and market and regulatory forces weighed on those institutions to put that money to work. Much of that enormous stack of cash flowed into the stock market—with stocks historically being the most profitable investment vehicle in which to park money. The S&P 500 index and most other indices moved sharply higher despite the higher risk from the contracting economic environment. Demand for stocks increased dramatically from the Fed’s infusion—even if higher prices were unjustified by stock fundamentals.

The Fed unhinged the finely balanced Supply-Demand relationship that has informed investment markets for more than two centuries, pouring trillions of dollars into the demand side, and the result today is clear. During the current recession and market selloff, most proven macroeconomic and fundamental indicators, including Unemployment, Yield Spreads, Industrial Production, Industry Health, Valuation, S&P 500 Earnings, and more… all failed to provide accurate signals for stock price trends for the first time ever.

Initially, this money poured into technology-based, stay-at-home-facilitating FANGMAN stocks, but after a month, that tiny corner of the market played out from extreme valuations, then the money poured into technology shares that had been performing poorly in the real economy and had little demand.

So, what went up most in 2020? Money-losing tech companies! The more money lost, the better, apparently. 2020 was truly the year of ‘Revenge of the Losers.‘ Just like the late-1990s dot-com rally, profits didn’t matter. The only thing important in the 1990s was growth in “eyeballs” (i.e., pageviews). A similar situation began in 2020 and continues today. Just like the late-1990s, it likely won’t end well.

Historically, any market dynamic not based on measurable fundamentals could have its day in the sun—for a short while. However, eventually, that lack of fundamental support for an investment concept would rear its ugly head, and the speculators who were essentially riding a Ponzi scheme would be left empty-handed when the music stopped. So too, in this new dynamic, money-losing tech stocks are still just money-losing companies with little or no value, and those shares will reflect that reality sooner or later. Once the Reddit Wall Street Bets traders drive all the shorts to sell, they will move on to greener fields. Gamestop, AMC, and other stocks will be abandoned and left in a smoldering ruins.

While the Fed and Congress created a $6 trillion demand imbalance, eventually that money will be fully absorbed by the market and will disperse across the approx. 8,000 investible non-penny stocks and 2,500 ETFs that are available to investors. However, the next time the US faces an economic recession, will investors expect the Fed to intervene again to halt and reverse an emergent bear market?

My guess is that there is a 100% chance that investors will expect this to happen. With the Federal Reserve now seeing just how powerful its tools can be, it would be amazing if the next Fed Chairman doesn’t want to be the hero that ‘saves the market and economy.’ If that doesn’t happen—if the Fed doesn’t intervene with a massive QE infusion—the stock market will likely see a dramatic collapse.

Since the Federal Reserve’s massive interference in markets in March last year, most proven macroeconomic and fundamental indicators, including Unemployment, Yield Spreads, Industrial Production, Industry Health, Valuation, S&P 500 Earnings, and more… have all failed to provide accurate signals for stock price trends for the first time in history.

Since the dramatic change to markets last March, the underlying financial aspects of a particular stock or ETF have become less important than the fact that its share price has gained upward momentum (or has not). The price-momentum winners are rewarded with more funds and momentum, while the temporary losers get punished with selling, left behind, and forgotten.

In a season of unprecedented events, what happened in investment markets during 2020 was unprecedented to an extreme degree, with central banks upending the balanced foundations of investing that have been in place since the first stock was traded on the first stock exchange in 1600’s Amsterdam.

On a fundamental level, a company’s stock price serves as a discounting mechanism, per share, of its future profitability. These days, that relationship no longer applies to many publicly traded companies.

With the Fed now discovering how easy it is to virtually eliminate long, severe market declines by delivering ‘helicopter money,’ what’s the chance it won’t continue to manipulate the market?

Yes—that’s what we concluded, too: Highly unlikely. Nil. Zip. Squat. Zero. The most significant market indicator may be tracking the Fed balance sheet’s growth or decline.

Whenever a severe economic contraction threatens corporate share prices, might the Fed Chairman pull out the Unlimited Quantitative Easing (QE) instruction manual from 2020, pour trillions into the banking system yet again, and watch equity markets ‘magically’ levitate? What’s to stop him/her? There is no approval required, other than the Fed Board of Governors.

Wouldn’t that be nice—to know we never need to worry about a significant loss of capital in the stock market because the ‘Fed Put’ is always there? Do we even want the Fed always to have our back? Well, be careful what you wish for because you may not like the unintended consequences that accompany that scenario.

If the Fed’s 2020 approach to economic contractions continues, it will cause unintended consequences and might permanently hobble the US economy. When you manipulate asset prices so much those assets no longer have a relationship with underlying profits and other fundamentals, it is a slippery slope.

We will lose true price discovery. We will lose the benefits of creative destruction that has fueled America’s entrepreneurial spirit for two centuries. We will create zombie companies like Gamestop or AMC that cannot survive on their own and will depend on tapping a never-falling market to survive.

Let’s face it: Manipulating asset prices was the straight-up intention of the Federal Reserve with its announcement in March 2020. Besides providing liquidity to keep the financial system operational, it wanted to halt and reverse the emergent bear market. However, is that really part of the Federal Reserve’s objective, which supposedly consists of supporting full employment and limited inflation? While providing liquidity to support continuing market functions is a valuable objective, last March the Fed “jumped the shark” with its $3.5 trillion infusion.

It seems obvious that $3.2 trillion was far more money than was needed to do the job, otherwise the stock market would not have climbed so far so fast into extremely overvalued conditions. Instead of doing the minimum to shore up and support the financial system, much of that system is now disconnected from a basis in reality. One can only hope that the Fed was simply not aware that Congress was also going to spend $2 trillion at the same time, sending direct checks to every US adult who filed a tax return. The combination of the two massive infusions is what has elevated the S&P 500 to a PE of 40.93 (long-term average is 15). The Russell 2000 currently has a forward PE ratio of 68.69, which is unsustainable.

Reversion to the mean is the most powerful force in investing… and one day….this is going to get ugly.

 

Thought of the Week

 

There are good ships and wood ships and many ships that sail the see but the best ships are friendships and may they always be!

 

 

All content is the opinion of Brian J. Decker