The markets never make it easy. The first quarter was marked by a number of headwinds that investors are still wrestling with today as volatility continues. High-growth stocks have generally been hurt the most, but overall, stocks suffered their worst quarter in two years….and it has been the worst start for the markets since 1939!
The war in Ukraine and the shutdown in China due to increased Covid outbreaks have kept a broad cloud over the markets. But ultimately, inflation and how the Fed manages interest rates have drawn the most attention from investors. The economy continues to be strong and unemployment remains very low. However, inflation has been much more persistent than previously forecast---and the situation in Ukraine has only compounded the supply chain problems.
For the first time since March 2018, the Fed raised interest rates in the first quarter. On Wednesday, Powell once again increased rates by .50%., pledging that the Fed would be vigilant in fighting inflation. We expect to see additional interest rate hikes, but it remains questionable as to whether the Fed will be able to implement as many as the market has been anticipating.
Meanwhile, as rates have moved higher, the reaction in the bond market has been swift and severe. (Note: bond prices move inversely to interest rates.) Today’s bond prices are already discounting MULTIPLE future rate hikes by the Fed. For the 1st quarter, the Bloomberg U.S. Aggregate bond index—which includes largely U.S. Treasury’s, highly-rated corporate bonds and mortgage-backed securities—declined by over 6%, the largest quarterly loss since 1980. For the first time in quite a while, bonds have offered very little buffer to the weakness in stocks.
However, although the markets have been facing an extraordinary “confluence” of issues, all investments should not be grouped together. Yes, most stocks saw declines in the first quarter and growth and technology stocks, in particular, took the brunt of the punishment. As we’ve highlighted, these are the most expensive stocks—i.e., those with lofty P/E valuations—and are also the most exposed when rates rise.
But some big blue-chip names in sectors like healthcare, consumer defensive, utilities and energy are performing very well, some near 52-week highs. In fact, many of the option-writing strategies and other income-generating stocks/ETFs have fared very well on a relative basis. And as we always try to highlight, dividends provide the best way for investors to keep up with inflation for the long-haul.
Going forward, the economy will grapple with inflation and higher rates, while investors will watch corporate earnings and the Fed. Earnings continue to come in positive, but company outlooks have been mixed. Until there is more clarity on Ukraine, China and the Fed, the markets will likely show further volatility.
Dividends: The Secret Weapon to Inflation
One of the best bear market protection and inflation fighting strategies is hidden in plain sight: Dividend paying stocks.
We discuss the importance of dividends a great deal. However, in today’s high inflation environment, this topic becomes even more apparent as the steady stream of consistent income that dividends provide is one of the best ways to fight inflation.
For many investors, the idea of dividends is boring. Most investors want “high” growth, if not “quick” growth. But few realize the benefits of a dividend strategy over the long-term. After all, total return calculation includes not only price appreciation, but also paid dividends---which for many companies, are increased year after year.
First, companies that pay dividends generally have mature businesses with solid cashflows. In most cases, these companies hold their dividends in high regard, doing everything in their power to preserve these payouts. In fact, as financial author, Mark Hulbert, wrote in a recent article, “When focusing on all rolling 12-month periods since 1940, the S&P 500’s earnings per share have been 10 times more volatile than dividends per share (DPS).” Takeaway? Even though a company’s earnings may fluctuate, their dividends will remain largely consistent, if not growing.
And this is particularly effective during periods of inflation; in fact, according to Mr. Hulbert’s work, “Dividends per share growth has outpaced inflation by 2.4% per year on a rolling 12-month period since 1940.” So having a steady stream of income that beats inflation can also take a lot of stress out of the portfolio!
Investors today are scrambling to find investments to counter the high inflation rates and protect them from the market volatility. And Wall Street will certainly oblige with a long list of ideas. Buy commodities! Cryptocurrencies! Weren’t cryptos supposed to be this great hedge against inflation? TIPS! Private credit! Structured Notes! Annuities! Hedge Funds! Private Real Estate! While it is true that all investments at least temporarily have their day in the sun at some point, very few, if any, can match the long-term power of simple, low-cost dividend growth strategies.
Sometimes the simplest answer is the best. As Warren Buffett said at his annual meeting, “Wall Street doesn’t make money unless people do things and they get a piece of them.”
Understanding Risk vs. Volatility
During challenging market periods, it is important for investors to remember the distinction between volatility and risk. For many who forget or do not understand this difference, the impact on their investments can be significant. In her 2020 article “Risk, Not Volatility, Is The Real Enemy,” (revised in 2021), Morningstar’s Christine Benz explains these two terms and does an excellent job in reminding us not only why we invest, but how the markets work.
To paraphrase Ms. Benz, “It’s easy for investors to feel more risk-resilient when markets are sailing along, and become more risk-averse during periods of sustained losses.” Of course, this is human nature. We feel comfortable when things are going well, but much more prudent when things change course. Unfortunately, when it comes to the market and investing, prices do not move in a straight line; volatility is a normal part of long-term investing.
However, price volatility and risk are different. As Ms. Benz defines it: “Volatility encompasses the changes in the price of a security, a portfolio, or a market segment both on the upside and for the ill (downside.) Such fluctuations are inevitable once you venture beyond certificates of deposit, money market funds, or your passbook savings account.”
Alternatively, she defines the term “risk” as: “The most intuitive definition of risk, by contrast, is the chance that you won’t be able to meet your financial goals and obligations or that you’ll have to recalibrate your goals because your investments came up short.”
Naturally, the most important risk to avoid is the permanent impairment of capital. This can be created by investing in highly-speculative and “binary-outcome” investments. For long-term investors, this type of risk should always be avoided. However, what about another type of risk? Keeping money in a bank savings account—or under a mattress—holds virtually zero risk of capital. And in periods of volatility, it is safe and will feel secure. But when we factor in the effects of inflation and the opportunity costs of lost investment gains (over time), the risk to long-term buying power is tremendous.
In weak market periods, it’s easy to feel that the best investment idea is to.… ”throw in the towel.” However, it is a mistake to blur day-to-day, normal “volatility” with permanent investment “risk.” And as we continuously emphasize-- for those who are able to understand this important difference, it will be much easier to avoid being influenced by short-term trading volatility, while standing a much better chance of attaining (or sustaining) their long-term investment goals.
The bottom line: Investors must be able to separate risk from volatility in order to increase the likelihood of achieving their financial goals. The fluctuation in the value of your portfolio from Jan 1st until today? That’s just volatility. Not growing a nest egg to keep up with inflation and your retirement goals…Or having to go back to work when you are 75 because you didn’t have a good investment plan…Or thought you could time the market….Or invested too conservatively….Or became too greedy when markets were up and fearful when they were down? That’s risk.
Financial Planning: Philanthropic Strategies
With the tax deadline in the rearview mirror, we can all breathe a sigh of relief – that is unless you had to file an extension on your 2021 tax return… With taxes still top of mind, it is good practice to start early in planning your annual tax strategies. For those people who are philanthropic, a charitable contribution is a great way to not only reduce your annual tax liability, but to have a positive impact and make you feel good too! There are a few important factors to consider when planning out your charitable contributions.
First, in order to receive a tax deduction for a charitable contribution, you must be certain that you will itemize your deductions on your tax return. Generally, you will itemize deductions if these are larger than the standard deduction. In 2022, the standard deduction for Single and Married Filing Jointly are $12,950 & $25,900, respectively. You can find more detailed information about tax deductions in our February Newsletter.
Second, charitable contributions can be made using a variety of assets including, cash, personal or real property (e.g., vehicles & residences), intangible property (e.g., stocks & bonds) and other assets. When gifting to a charity, it is important to consider timing and the tax impact of the gifts you are giving. For example, it is tax-advantageous to time your charitable giving in years when your taxable income is high. For some people this might be a moot point if your income is fairly consistent each year, but it is imperative for those with more variable or lumpy income to time charitable contributions in years of high income. Additionally, it is important to consider the tax benefit you will receive from your donation. For example, if you donate cash to a charity your donation is subject to a maximum of 60% of AGI limitation, while a gift of stock is subject to a 30% of AGI limitation. It should be noted that a gift of stock shares held for more than twelve months provide a tax deduction equal to their current fair market value and the donor avoids paying any associated capital gains taxes on the shares that are gifted. That said, the donor should look to gift shares that have been held for at least 12 months and have the largest percentage of capital gain. Any charitable deduction which cannot be used in the current tax year can be carried forward for five years.
Third, individuals and families who plan to gift on a consistent basis each year may want to consider bunching their gifting. Charitable gift bunching is a strategy that makes a large one-time gift during a year when the donor has a high amount of taxable income. For example, if you typically donate $10,000 per year, then you could make a one-time contribution of $100,000. For clients who choose to do this strategy, we typically look to set up and make this gift to a Donor-Advised Fund (DAF). Using the same example, a DAF would allow the donor to take a charitable deduction of $100,000 in the year the contribution was made. Furthermore, the donor can choose to make gifts from their fund to the charities of their choice during the rest of their life (and even during the lives of their heirs). To top things off, donors can fund a DAF with a gift of appreciated stock and can even continue investing the capital inside of their DAF!
In summary, when considering a charitable donation, it certainly makes sense to review the tax implications of your contribution and consider the best strategy to not only meet your philanthropic goals, but to do so in a tax-efficient way. If you should have any questions about your personal charitable contributions, please feel free to reach out to us.
As always, we would love to hear back from you if you should have any questions about anything in our newsletter. Thank 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.