“Investing isn’t about beating others at their game. It’s about controlling yourself at your own game.” – Ben Graham, author of “The Intelligent Investor”
While the trend this year has clearly been negative, markets continue to trade in a wide range over the last several months, essentially moving in step with the daily economic headlines…or, as it may be, comments from the Federal Reserve.
The current market concerns are largely interconnected---and almost “circular” in nature. That is, questions about the future health of the economy (e.g., growth and employment) are largely predicated on the ability of the Fed to control inflation by raising interest rates. But, of course, to what level the Fed feels it necessary to raise rates will undoubtedly impact the economy. In hiking rates, the Fed is purposely causing an economic slowdown to curb demand, but in raising too much, they threaten to ignite a recession; in doing too little, inflation will remain persistent. However, some would argue that the high inflation problem is more of a supply side issue and the Fed can’t do anything about producing more oil or food.
At the same time, the war in Ukraine continues to be a dark cloud on the entire world, both from a humanity standpoint as well as a burden economically. While its resolution remains unpredictable, this conflict has had a severe impact on energy prices as well as supply chains, only adding to the global inflation problem.
And adding yet still to this inflation/supply chain quandary is China, which still cannot seem to beat Covid. The effect of this is felt throughout global supply chains as many of China’s ports and factories remain in lockdown; in fact, most recently, Apple announced it would not be able to meet demand for its newest phone due to one of its Chinese suppliers being shuttered for Covid.
Meanwhile, despite the headwinds, the US economy and the markets have both shown resiliency; unemployment is at historically very low levels, while personal and corporate balance sheets generally remain solid. As for corporate earnings, 3rd quarter results have been truly a mixed batch. Overall, most current numbers were not as weak as expected, although many companies did begin to lower guidance for the future, fearing the effects of higher rates and a slowing economy. And even though the market has pushed prices to much more reasonable levels, there are still areas which trade at lofty valuations.
The good news looking forward is that the bubble in tech stocks and speculative stories like crypto’s, EV’s, SPAC’s, IPO’s and other areas has finally burst. It’s probably not complete yet but these areas of the markets have been deservedly decimated. Real earnings, dividends, and reasonable valuations finally matter again! Some other good news looking forward is with the rise in yields the bond market looks more attractive than it has in a very long time.
Sure 2022 has been a tough year for both the stock and bond markets. But if you stayed disciplined, stuck to a good diversified strategy, didn’t chase yield, didn’t get greedy and chase overvalued, overhyped speculative non profitable bubble stocks, then you are doing just fine and can survive this bear market. Valuations are still not cheap in large cap growth, but many other areas of the market sport below average valuations. Investors who invested just for “high yield” or were overweight in speculative stocks are in a world of pain. Slow and steady always wins the race. Here’s a simple example: Campbell Soup Stock has outperformed Amazon stock over the last 3 years. When overvalued and very popular stocks get hit, they get hit hard and fast. If 3 years ago we said you should buy Campbell Soup over Amazon, what would you have thought?
A Misunderstood Investment Strategy
We’ve said it a thousand times- option strategies have been misunderstood. However, because many of these strategies have performed quite well in this bear market, unfortunately, they are starting to get very popular! Money is now pouring in to them because--as usual--too many investors just chase the latest best performers!
There are many different ways to implement options strategies into portfolios-too many for us to describe here. The problem is too many investors use them the WRONG way- for speculation purposes. Used appropriately, options can lower the risk of a portfolio and/or increase the income generated. It is for these specific reasons that the right options strategies have indeed helped investors weather this bear market better than most.
Please CLICK the link below to review a related video from our very own Taylor Thomas for more of an explanation on this strategy, which we call “Harvesting Volatility”.
Tax Consideration: Mutual Fund Distributions
As we enter the final months of the year, mutual funds begin to provide estimates of how much they will pay out in income and capital gains. This gives shareholders some idea of what their tax bill may look like, but it also raises important issues for most investors to consider.
Throughout any given year, mutual funds will sell positions to meet redemptions, outflows, etc. Such proceeds are required to pass through to shareholders, resulting in long-term or short-term gains or losses. As a general rule, it is always prudent for individuals to monitor how much in capital gains they will be receiving. And during this time of year, as mutual funds provide information on their distributions, investors will have the opportunity to offset any gains with losses in other positions.
In down market years, however, investors may face a situation where they are required to pay capital gains on a mutual fund position in which….. they have lost money! How is this possible? Well, if the mutual fund sells positions in which it has gains, but those profits were made PRIOR to the investor buying said mutual fund, the resulting capital gains tax bill is shared among ALL shareholders, regardless of their holding period. (This is also why it is imperative that investors understand when distributions are being made, so as not to purchase the mutual fund right before the price drops as a result of the distribution.) Investors should be careful about any new purchases (in taxable accounts) in funds that have upcoming capital gain distributions.
In such cases of a looming cap gains tax bill, some investors may find it advantageous to sell the mutual fund before the distributions are made; that is, for those who are facing a current loss--or even a small gain on the holding, it may be more tax efficient to sell and avoid the tax. Of course, for longer-term holders of the mutual fund, those who have enjoyed significant appreciation in the fund and are sitting on significant long-term gains themselves, it most likely may NOT be wise to liquidate the position.
There are additional tips for planning around capital gains; for example, important decisions should be made of how assets are initially allocated between accounts. With the goal of minimizing taxes, investors should determine the characteristics of the asset and which should go into taxable accounts, which into non-taxed accounts. For example, if a position generates significant income or dividends, it may be appropriate for a non-taxed, retirement account. Similarly, for those positions where capital gains can be directly controlled, a taxable account may be preferrable. This strategy is called “Asset Location” and is often overlooked by most investors.
In summary, most investors do not understand or ignore these issues surrounding the impact of capital gains. If not monitored properly, 2022 might be a year where some investors lose money AND pay taxes. Asset location and tax aware investing is an important part of successful financial planning.
Due Diligence on Financial Advisors
As a firm that stands behind the meaning of being an independent, fee-only fiduciary wealth management firm and believes that most investors are better served by firms held to these standards, we must admit it was with great disappointment when we read Jason Zweig’s Intelligent Investor column in the weekend’s Wall Street Journal.
The reason Zweig had always thought investors would be better served by advisors over brokers is because advisors (we thought) have to disclose more about themselves in SEC filings. This would lead to investors making better informed decisions about the advisory firm’s integrity and services. As Zweig notes, that is not always the case. When it comes to ADV disclosures, according to the SEC, it is up to the firm to decide if any civil lawsuits, customer complaints or arbitration claims are material enough to disclose.
Zweig cites one firm that was sued for $4 million over claims of fraud and misinterpretation after private funds it recommended to clients lost millions of dollars. This wasn’t disclosed on their ADV. Zweig cites some other firms, as well.
The takeaway for investors: Do your due diligence on advisors. Start with their listing on https://adviserinfo.sec.gov and look under the disclosures section.
But don’t just end there; ask more questions! As we also just unfortunately learned, not everything has to be disclosed!
And do more due diligence for firms that do a lot of “private” investment business or insurance (annuity) business. Remember as we’ve also said a thousand times….The ETF business is eating Wall Street’s lunch. It’s forcing too many firms to go into areas with much higher underlying (and often, hidden) fees. We are sticking to our belief and philosophy of serving investors with low-cost, publicly-traded securities like ETF’s and mutual funds.
In closing, please let us know your thoughts and/or any questions you should have on any of the topics we discussed in this letter. 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.