For the financial markets, 2022 was a good year to put in the rearview mirror, as both stocks and bonds faced a very difficult environment. In fact, according to a recent Wall Street Journal article by Jason Zweig (Jan 7-8, 2023): “In 2022, a 60/40 portfolio (stocks/bonds) had one of their worst years in history.” Quoting data from T. Rowe Price Group, Zweig further notes: “the typical 60/40 portfolio’s extreme losses last year had a probability of occurring only once in every 130 years.”
Last year was made particularly challenging by the rise of high inflation and the corresponding interest rate hikes by the Fed to combat it. As rates shot up at a rapid pace, bonds—instead of offsetting the volatility with more price stability—reacted in contrary fashion. As Zweig described it: “Instead of as a ballast in a balanced portfolio, bonds acted like a torpedo.”
However, as we enter 2023, interest rates have actually started to decline, allowing bonds to rally. Worries still remain that the Fed may have already done enough with rates to push the economy into a recession. But with the recent data showing that inflation may be slowing, the Fed may now have some latitude in moderating future hikes. And though the Fed’s primary objective of slowing demand has likely been achieved, it does not mean that the economy needs to fall off a cliff. In fact, with unemployment numbers as low as they have been, a deep, prolonged recession seems rather unlikely.
Nonetheless, companies are now starting to report 4th quarter 2022 earnings, and more importantly, will be providing guidance for the new year. These estimates will be very telling. While it is possible that the Fed may be nearer to ending its interest rate hikes, we just don’t know what level of slowdown in demand they have already caused and what effect this will have on company profits.
Either way, there are a number of positives for investors to consider. First, as mentioned, inflation does look to be slowing and the Fed may pause sooner than expected. Second, China is beginning to re-open its economy which helps supply chains, as well as global demand. Lastly, the financial markets have been pricing in much of all the bad news throughout 2022 and valuations, especially within fixed-income, look better than they have previously. As we always stress, markets are a leading indicator so Wall Street may already be moving higher even if Main Street is seen dipping.
We still believe there are expensive areas of the market which may be particularly susceptible--especially if earnings’ estimates come down materially. However, many value stocks (particularly those that pay dividends and those strategies that include them) continue to look compelling. These are asset classes that have outperformed in 2022 and may continue to do so even if the economy slows.
In closing, as Mr. Zweig ended with wise advice:
“(A balanced portfolio approach) didn’t work in 2022. It may not even work in 2023. Over the longer term, though, it should work just fine.”
NCM Rants: The 60/40 portfolio, The “Active/Passive” Debate and Behavioral Finance
As we enter 2023, investors are once again questioning the validity of a 60/40 portfolio. Investors who followed this basic 60/40 mix (60% stocks, 40% bonds) in a simple index fund strategy that is typically market cap weighted were blindsided by double digit percentage losses on both their stocks and bonds in 2022. In fact, since 1928 there have been only 5 times where BOTH stocks and bonds have declined in the same year; 2022 was the first time ever that they both declined by double digit percentages.
So, is It time to abandon the 60/40 standard mix? The short answer is no, BUT the real question is how do you invest to get the 60% in stocks and 40% in bonds: should your allocation actually be 60/40 (perhaps no, in our opinion) and should you consider other asset classes (absolutely, in our opinion).
First, it is important to note that even just within the equity asset class there were huge dispersions in returns in 2022 underneath the surface. For example, if one just invested in the three simple fund index models, you may have saved a little in expenses/fees, but that portfolio really suffered in 2022; from our perspective, much more diversification is warranted than in merely “market cap weighted” total market funds. Additionally, we want to be very careful about how we get our bond exposure; many popular bond funds have gotten too big in our opinion and probably were forced sellers last year as redemptions hit.
So actively managed funds must be the answer? Well, according to Morningstar, 62% of active US stock funds beat their respective benchmarks in 2022. Naturally, active management pundits are touting these numbers and declaring victory: active management is back! But should they be? We’d argue no. Active managers blamed their underperformance for the prior years on the Federal Reserve keeping yields artificially low, causing low volatility and high asset correlations across the board. Well, as the saying goes, be careful what you ask for…..
In 2022, volatility was up markedly, interest rates shot up and there were asset class dispersions all over the place; for example, energy sector up 64%, tech down 30% plus, dividend index flattish, consumer staples flattish. This is the environment that they claimed to need to outperform, but did they really? Well, since slightly more than half outperformed, it could be considered a narrow “win.” But from our view, in a year where active managers couldn’t have asked for a better backdrop, this narrow margin of outperformance does not appear to be a game-changer in the debate of passive vs. active management. Instead, our view remains the same: some type of index or index related fund should be baseline for evaluation; from there, a strict set of criteria needs to be met for us to add an active fund to our strategies.
Behavioral finance is the study of the effects of psychology on investors and financial markets. Over the years, it has become a significant point of focus. Let’s discuss two tenets of behavioral finance: anchoring bias and confirmation bias.
Anchoring bias occurs when an individual’s decision is influenced by a particular reference point or an “anchor”. Stated differently, this occurs when people make decisions relying too much on pre-existing and recent information that may not be relevant, but they cannot easily dismiss. Here are two examples of this bias all investors should try to avoid:
First. After 2022’s tech crash, many investors are now reluctant to sell their tech stocks because they are “anchored” to the fact that they paid much higher prices for these positions in the past; these investors do not want to sell at today’s prices and realize the loss. However, the fact is this is 100% the wrong approach. What an investor paid for a security in the past is essentially irrelevant when it comes to the decision to sell it. Instead, the question should be: Is it still a good investment at today’s price? Far too many investors struggle with this bias and this only sets them back from achieving their financial goals. Successful investors have to be able to look at their portfolios at today’s prices and not let the prices they paid influence their decisions too much.
Second example. Coming off a strong market year in 2021, market strategists all had rosy forecasts for 2022 with an average year-end target for the S&P of 4900. As we all know, the S&P ended 2022 below 3900…..considerably lower (1000 points!) than the average target. Strategists were influenced by the recent events and strong year of 2021. Conversely, today, they are anchored by 2022’s poor performance. And guess what? Nearly all their forecasts for 2023 are, not surprisingly, very pessimistic!
Confirmation bias is the tendency to only seek out information that supports your own views. When I read through my twitter feed, I noticed how pundits who are positive on the markets only retweet views that are also positive and vice versa, the bearish tweeters only retweet bearish views. Furthermore, whenever we go to conferences put on by investment firms that have products which primarily perform well In DOWN markets, the featured speaker has been someone with a negative or bearish view on the market. Not surprising.
- All investors must fight off confirmation bias and anchoring bias; try to be objective and challenge your own thinking by listening to and respecting other views.
- Be very selective when considering “paying up” for active individual fund management; the odds of success are generally not in your favor.
- Carefully think about how you build your investment portfolio; 60% in stocks and 40% in bonds can take many different forms. 2022 is an example of why just buying a “total market fund” may not be your best choice. Compare the results of the 2000-2010 decade where true diversification between asset classes, as well as active vs. passive funds, outperformed.
Some Key Aspects of the Secure 2.0 Act
On December 29th, 2022, President Biden signed the SECURE 2.0 Act of 2022 (“the Act”) in law. The Act is more than 350 page and has likely made some of the largest changes to retirement plans since 2006 when the Pension Protection Act was released. From changes to Required Minimum Distributions (RMDs) to student debt, the Act has a wide variety of material to consider – we highlight some of the important items below:
- The age to start taking these distributions increases from 72 to 73 in 2023 and then increases again to 75 in 2033
- Starting in 2024 – RMDs will not be required for ROTH accounts that are part of an employer-sponsored plan, like a 401k
- Both the initial and 2.0 versions of the SECURE Act made many important changes to the RMD calculations for account owners as well as those who were a beneficiary of a retirement account, so please be sure to check the rules if you have questions or reach out to us if you need assistance.
Retirement Plan Contributions
- Starting in 2025 – catch-up retirement plan contributions will increase to $10,000 for those who are 60-63 years old and part of an employer-sponsored plan (e.g. 401k & 403b). Currently these catch-up contributions are $7,500 for individuals who are 50 years old and older. However, for those making more than $145,000, all catch-up contributions in a 401k (and other retirement plans) must be made in a Roth 401 component. For IRA accounts, the catch-up contribution remains the same at $1,000 for those who are 50 years old and older. Additionally, all catch-up contributions will be indexed for inflation annually.
- Starting in 2024 – defined contribution plans, a 401k for example, will have the option to include a Roth account which could be used to save for unexpected short-term expenses. This feature would be only for non-highly compensated employees and contributions would be set by the employer but limited to a maximum of $2,500. The first 4 disbursements within a year would be tax- and penalty-free and would allow participants to save for large & unexpected expenses in a tax-free environment.
- Starting in 2024…
- employers will have the option to “match” student loan payments with an employer-contribution to that participants retirement account.
- 529 plan assets (up to a maximum of $35,000) can be rolled over (subject to annual contribution limits) into a Roth IRA for the beneficiary. The 529 account MUST have been open for at least 15 years and contributions to the 529 within the last 5 years are not eligible for transfer.
- For those individuals who are philanthropic, the Qualified Charitable Distribution (QCD - created in 2006) allows for an IRA account owner (who must be at least 70½) to send up to $100,000 per year from his/her IRA to certain charities. A QCD will qualify for the account owners RMD (where applicable). The Secure 2.0 Act provides for this amount to be indexed by inflation (starting in 2023) and further allows a one-time gift up to $50,000 to other charitable entities including a charitable remainder unitrust, charitable remainder annuity trust or a charitable gift annuity.
In closing, we hope you found this information helpful and informative. We welcome your thoughts and questions and we look forward to speaking with you.
All the best,
NCM Capital Management
DISCLOSURE: This newsletter contains general information that may not apply to everyone. The information above should not be construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security. Past performance is no guarantee for future results. There is no guarantee that the opinions expressed in this newsletter will occur.
Investment advisory services are offered through NCM Capital Management, LLC, an SEC-registered wealth advisory firm domiciled in New Jersey. This communication is not to be construed or interpreted as a solicitation or offer to sell investment advisory services to any residents of any state other than the State of New Jersey, the State of New York, the State of Texas, or where otherwise legally permitted. For additional information about NCM Capital Management, LLC, you may request a copy of our disclosure statement as set forth on Form ADV.