Market Outlook & Insights — Atlas Financial Advisors

Special Report - October 2024

Atlas Financial Advisors is providing this special report in light of several warning signals that have emerged in the US stock market and globally (assets and events). These are long-term indicators that can take more time to turn, but we think they merit caution with your portfolio allocations if you are heavily weighted in stocks, and especially tech stocks.

Valuation Warnings

In the chart below, the spread between equities valuations vs. commodities prices have never been this extreme. The 3 times this level of divergence occurred since 1900 it has led to a dramatic pullback in stocks and a large spike in commodities.

These value extremes would suggest shifting out of equities into commodities has a high probability of being a profitable trade over the next few years. Again, it may take further time for the shift to start in earnest, but picking the right dividend-paying companies in the several major commodities sectors would allow investors to earn dividends while we wait for this event to unfold.

The next chart is what Warren Buffett calls "the best single measure of where valuations stand." Known as the Buffett Ratio, it compares the market's value to GDP. This indicator just hit the highest level on record, breaking it’s prior 2022 peak (which peak BTW was followed by a 25% drop in the S&P500).

The Buffet Ratio is well above the highs of both the dot-com bubble and the leadup to the 2008 financial crisis. The valuation run-up from the 2009’s low to today’s high was largely driven by Federal Reserve engineering that pushed interest rates lower through “quantitative easing” as well as its subsequent response to the COVID pandemic. These initiatives are now a thing of the past. And though they boosted the economy and financial assets at the time, they also drove inflation and the national debt (now at $36 trillion) sharply higher. The Fed’s posture now, after raising the Fed Funds rate 500 basis points, is focused on getting inflation lower, not goosing the economy and re-stimulating inflation.

Similarities of the Decades 1999-2009 and 2014-2024

Probably the most instructive decade to compare to is 1999-2009. In the 1990s, the S&P 500 notched a four-fold leap and produced a total return by a multiple of more than five for the decade. Those eye-popping gains extended a rally started in the 1980s, where the benchmark index returned 396% (source: Ned Davis Research, MarketWatch 2009).

In the decade that followed, the S&P 500 was essentially flat and in fact returned an annual average loss of -0.95%. Stocks as a whole had a lost decade, especially tech stocks.

The chart below shows the Buffett Ratio at the 1999 market top (34%) before the start of a 3-year bear market, and today’s current level (44%). The Dot-Com bubble was followed by a roughly 50% drop in the tech sector. We are at a much higher valuation level today than we were before that market collapse of 2000-2003.

So what did do well during this abysmal decade? Commodities, especially energy, metals and materials companies. For example, the energy sector of the S&P 500 during this period returned 144%, or an average of 14.4% a year. During the same period the S&P500 was negative. (Source: Moneywise 2023)

Other Pressures to Consider

We have some positives to report below, but lastly on the negative front, investors should not be complacent about the following:

Interest rates have declined from the 5% rise of 2022-2023, but the days of aggressive easing that fueled much of the valuation rise appear to be over
Our national debt is growing unabated to levels where it now appears taxes will not be able to cover the annual interest cost (see www.pgpf.org for more info)
Whereas government spending historically stimulated significant rises in GDP, that effect has dropped steadily since the deficit began to explode to where it now has no meaningful upside impact
Geo-political risks continue to reach new heights, complicated by constantly emerging technology risks and coordinated nation-state efforts to weaken the US
Our nation is as polarized as it’s ever been as we head into a Presidential election
Individual investors are extraordinarily bullish and invested in stocks, traditionally an indicator of at least an interim market top (see the Fear and Greed Index below).

Are There Any Positives Out There?

Leveraging analysis from the National Bureau of Economic Research (NBER) and an excellent market technician we follow, we see there are quite a few positives still are out there that are keeping valuations afloat. There are four data points that NBER (the folks who call recessions) monitor. What are they saying as of September 30, 2024?

Personal Savings was revised upward to 4.8%
Personal Consumption Expenditures (PCE) year-over-year is at pre-Covid levels
Consumer loans (Credit Cards) have been decelerating since 2022
Consumer Delinquency on Credit Card payments have been decelerating since 2023

So, the economy is in better shape than many market prognosticators are willing to give it credit. Some other statistics that show a high probability of more stock market gains ahead:

The S&P 500 Index finished a 5-month winning streak at the end of September. Since 1928, after a 5-month winning streak, the economic cycle did not peak over the following 12 months in 35 of 38 times -- a 92% probability the current economic cycle still has more room to run.
After a 5-month winning streak, the historical probability the S&P 500 Index was higher 6 months later and 12 months later are both 84% (32 of 38).
The largest block of buyers of the stock market – institutional buyers – continue to add to their stock market positions.

Where Does this Leave Us?

As we stated at the outset, the warning flags we shared are long-term indicators that can take months - and sometimes years - to finally turn after reaching extreme levels. We are about 4 years into the equities-commodities spread low, and about 1 year into the Buffett Ratio high. But eventually these will turn. Perhaps this is why Warren Buffett has been heavily reducing his epic holdings in Apple and other stocks behind his success, and raising cash to record levels. These turns take time, but once they start they tend to move quickly. With the value of stocks no longer compelling. we can only guess Warren would rather leave the last bit on the table than have to chase prices that have already begun a downward spiral.

Accordingly, we believe it's time to shift allocations, selling tech stocks in particular, and any broad-market index funds or ETFs generally, and buying commodities stocks - as well as assets that historically rise when the US dollar weakens. Atlas Financial Advisors can provide specific recommendations to take advantage of this asset class shift. Contact us for further information.

September 2024 Planning Insights

For the next several months we will take a break from providing general market commentary and instead provide several Guides on financial topics that may be pertinent to your financial picture. This September 2024 edition addresses two related topics:

Strategies for Reducing Taxes on IRA Required Minimum Distributions (RMDs)
and
Converting a Traditional IRA to a ROTH IRA

Strategies for Reducing Taxes on Required Minimum Distributions (RMDs)

The tax you will pay on Retirement Account RMDs is an important cost to factor into a long term retirement plan. IRA distributions are considered ordinary income and as a result can push you into a higher tax bracket. Here are a few strategies to potentially reduce your RMD tax during retirement.

1. Start withdrawals sooner to maintain a lower tax bracket in later years
Once you reach age 59 1/2, you can begin taking distributions from retirement accounts without penalty. Many retirees hold off taking distributions until their RMD age (currently 73 if born before 1960, 75 if born in 1960 or later). On one hand, delaying withdrawals can help retirement account assets continue to grow. However, as the following tables show, delaying distributions may also push you into a higher tax bracket in your later retirement years. If you expect to continue to have consistent non-investment income in your retirement years, this strategy is worth taking a closer look at with your tax advisor.

Minimizing RMDs

Scenario 1 | Without pre-RMD withdrawals

Without pre-RMD withdrawals, RMDs push this investor into the 32% tax bracket in retirement.

Scenario 2 | With pre-RMD withdrawals

Making annual withdrawals prior to RMD age, up to the limit of the 24% tax bracket, helps keep the investor out of the 32% tax bracket in retirement.

Source: Schwab Center for Financial Research.

Calculations assume a married couple with $230,000 in combined taxable income and $2.5 million in combined tax-deferred accounts at age 65. Annual growth of 6% is added to the account balance at the end of each year, and nonportfolio income and tax brackets increase by 2% annually to account for inflation. Nonportfolio income may include business income, pension payments, rental income, Social Security benefits, etc. This hypothetical example is only for illustrative purposes. Tax changes and income fluctuations may negatively affect the outcome of this strategy.

Your expected income during retirement years, and the resulting tax brackets, will be the key determinants of the efficacy of this strategy. Again, consult your tax advisor to review different scenarios.

2. Make qualified charitable distributions (QCDs)
You can donate up to $100,000 per year directly from your IRA to qualified charities. This counts toward your RMD but is not taxed as income. QCDs are a great way to give to charities you had planned to support without tapping into your non-RMD income. You have to be 70 ½ or older to make an eligible QCD.

3. Consider a qualified longevity annuity contract (QLAC)
You can use up to $200,000 from your IRA to purchase a QLAC, which provides guaranteed income later in life. The QLAC amount is excluded from RMD calculations. QLACs are the only way to buy an annuity with pre-tax money that pays out guaranteed income at a later date. Tax is paid on the annuity distributions rather than the RMD.

4. Keep working past age 73
If you're still employed, you may be able to delay RMDs from your current employer's 401(k) plan until you retire. Unfortunately, this only works for your 401(k) at your current employer.

5. Donate your RMD to a 529 college savings plan
While this doesn't reduce taxes directly, it can be a tax-efficient way to save for education expenses that you had already planned to spend. RMDs are taxable distributions, but if you put RMD money into a 529 Plan, the money grows tax-deferred and can be withdrawn tax-free for educational expenses. You can also take the RMD from one account and put it into multiple 529s. If given to a parent or student 529 account, withdrawals for education expenses don’t count as income and are not taxed.

Should I convert my IRA to a ROTH?

Do you have a traditional or SEP IRA and have wondered if a ROTH IRA might be a better choice into your retirement years? If so, you’re not alone. This can be a confusing topic and the strategy has several pro’s and con’s.

First, let’s look at how the 2 types of retirement accounts differ. The fundamental difference is in how contributions and withdrawals are treated by Uncle Sam. Contributions to traditional IRAs are with pre-tax dollars, thus reducing your taxable income in the year you contribute; withdrawals are taxed at your modified gross income tax (MAGI) rate at the time of withdrawal (minimum age to withdraw without penalty is 59 ½). The IRS currently requires you to withdraw a minimum amount (the RMD) starting no later than age 73 (75 for those born in 1960 or later). RMD amounts increase each year based on an IRS life-expectancy table. If you don’t withdraw the full amount each year before the deadline, then a steep penalty is assessed: 25% of the amount not taken.

Contributions to ROTH accounts, on the other hand, are in dollars you already paid tax on, and withdrawals are not taxed including earnings on the contributions. The ROTH IRA has a 5-year holding period, so this needs to be factored into your retirement funding.

So why consider converting to a ROTH?

Apart from tax-free withdrawals on earnings, there is no required minimum distribution (RMD), allowing your assets to continue to grow if you don’t need to tap them. This gives you full flexibility on how much you can withdraw and when, starting from age 59 ½ (and assuming your ROTH is more than 5 years old). You also can continue to make contributions to the ROTH, though the limits are low ($7-8K) and restricted further by MAGI limits.

The negative of converting to a ROTH – especially from a large IRA – is you may be required to pay the top marginal tax rate of 37% on most or all of the entire conversion amount (the conversion amount is added to your total taxable income). Unless it’s a year of high income where you can afford to pay the tax all at once, this may not be the best strategy.

Alternatively, however, converting your IRA gradually can spread the increase in income over several years and avoid subjecting it to the top marginal tax rate. Spreading conversions over multiple years often makes the most financial sense for larger IRAs. This can help reduce the tax owed each year by potentially keeping you in a lower tax bracket.

It’s also important to consider when you’ll need to withdraw funds from your Roth IRA. As mentioned, funds can’t be withdrawn without penalty within five years of the conversion. If you convert your IRA to a Roth gradually over time, those conversions each re-trigger the five-year rule for that portion of the money. So you would need to keep track of how much was converted each year and when the 5-year period for each conversion ends.
Once again, your expected income and tax rate during retirement will be a key determinants on whether converting to a ROTH makes sense. Consult a tax advisor who can take you through different income and tax scenarios to determine what approach makes best sense for you.

Sources: IRS, Smart Asset, Perplexity AI

Disclaimer

The information presented in this document has been obtained from or based upon sources believed by Atlas Financial Advisors, LLC (“Atlas”) to be reliable, but Atlas does not represent or warrant its accuracy or completeness and is not responsible for losses or damages arising out of errors, omissions or changes or from the use of information presented in this document. This material does not purport to contain all of the information that an interested party may desire and, in fact, provides only a limited view. Any headings are for convenience of reference only and shall not be deemed to modify or influence the interpretation of the information contained.

This information is not investment research or a research recommendation, as it does not constitute substantive research or analysis. It is provided for informational purposes and does not constitute an invitation or offer to subscribe for or purchase any of the products mentioned. This document is not to be relied upon in substitution for the exercise of independent judgment.

Observations and views expressed herein may be changed by the personnel at any time without notice. This document is not to be reproduced, in whole or part, without the written consent of Atlas.

August 2024 Market Outlook

It’s probably just as well that our August monthly outlook is a few days late, given the volatility of the last handful of trading days and the sudden swing in market sentiment from optimism to fear. The CNN Fear and Greed Index (below) shows how quickly market sentiment can swing from Greed to Neutral to Extreme Fear.

Given the recent shell shock, we will keep this month’s missive brief and make a few key observations.

Bonds Now Outperform Stocks

Over the last several months we have been encouraging investors to take some profits in stocks and increase their percentage of fixed income assets substantially.

In the last month alone, the bell-weather S&P 500 and NASDAQ 100 indices have lost close to one-half and one-third, respectively, of their year-to-date gains (this includes today’s rebound in stocks).

In contrast, the fixed income markets have gained between +12% to +16%, depending on where on the yield curve one is invested (see last month’s explanation of the yield curve).

Stock and Bond Returns Over Several Time Periods

US Treasury 2-Year Note

· 1 Month +15.87%

· 3 Month +17.27%

· YTD +7.89%

US Treasury 10-Year Note

· 1 Month +12.29%

· 3 Month +13.00%

· YTD +1.39%

S&P 500

· 1 Month -4.77%

· 3 Month +2.34%

· YTD +11.15%

NASDAQ 100

1 Month -9.58%
3 Month +1.51%
YTD +10.55%

Shorter maturities in bonds (2-5 yrs) have now generally outperformed the major indices year-to-date.

Over the last 3-months, however, the out-performance of fixed income versus equities is staggering, ranging from about 10-15% higher net returns (5x to 7x return of bonds over stocks).

Our emphasis over these months to take some profits in stocks and especially to increase holdings in fixed income is now proving to be good counsel. Though the >6% yields we were regularly finding in AAA-rated mortgage backed securities and investment grade corporate and municipal bonds have faded somewhat in the last two months, we continue to find high quality 2-10 year bonds yielding 5-6%, and in some cases still over 6% for shorter maturities.

With recession talk rising and even the most reliable recession indicator (the Sahm Rule) signaling it’s coming, having a major segment of your portfolio in quality fixed income assets - at still attractive rates - makes more sense than ever.

Atlas Financial Advisors’ expertise is in finding high quality fixed income assets at prices that represent good value and reliable returns. If you are not already a client, contact us to discuss how we can help you add this important asset class to your investment portfolio.

Investment Team:
Direct (703) 980-7038
Main (561) 708-0400
Email: info@atlasfas.com

Disclaimer

Observations and views expressed herein may be changed by the personnel at any time without notice. This document is not to be reproduced, in whole or part, without the written consent of Atlas.

July 2024 Market Outlook

What’s an Inverted Yield Curve Anyway?

With equity markets sticking around all-time highs, the Federal Reserve holding short term rates “higher for longer”, and bonds mired in the same range we noted last month, we thought it might be useful to consider some implications of the unusual interest rate environment we are in today.

The US Treasuries (UST) “yield curve” provides a picture of the US Treasury’s borrowing rates over different time periods (overnight to 30-years). In a normal world, lenders demand a higher interest rate if a borrower wants to borrow money for a longer period. Not so today, at least for our US government. The UST yield curve has been in an “inverted yield curve” state since July 2022, where lenders to our government get a higher interest rate if they lend for shorter periods (say, 3-months) than they do if they lend for a longer period (say, 10 or 20 years). A full percentage point higher in fact.

US Treasuries Yield Curve (7/1/24):

You might ask, “who cares about an inverted yield curve?”. Probably all of us should, as a cautionary flag, if nothing else. The last time the Fed Funds rate was above 5% was August 2007, just before a financial markets meltdown and the start of the Great Recession. The yield curve inverted initially in January 2006, 22 months before the start of the 2008 recession. As of this July, we’ve had an inverted yield curve for 24-months. And no recession, yet. Just as the 2008 recession required a catalyst, so we will now. We have no idea what that might be, but exceptionally high geopolitical tensions, stubborn costs of basic goods and services, and a severely polarized US population both politically and economically are just a few potential candidates.

For now, however, a recession has been elusive. The US economy remains resilient, employment is still quite strong and corporate earnings are generally robust.

Investing Implications

The inverted yield curve has given investors yields over 5% in money market and short term government funds, a welcome rate of return after 15 years of zero and near-zero yields for these low risk instruments. As a result, money fund assets now stand at a record $6.1 trillion, with an approximate 60/40 split between institutional and retail investors. This makes for a lot of cash sitting on the sidelines waiting to find a place to invest. Much of this cash is nervous to take the plunge given major stock indices at all-time highs, valuations at high levels (at least for large caps), and rising political and economic uncertainties. The proverbial “wall of worry” is fully in play and continues to inch stocks to weekly new highs.

So, what to do with this bullish and bearish combination of a resilient economy and lots of cash versus rising valuations and global risks? In our view, the best approach is to ensure you have a significant percentage of fixed income securities (bonds) to buffer equities risk. As long as the Federal Reserve is in a holding pattern or looking to cut rates, bonds offer excellent value. We have been harping on this theme since last October. We continue to find 6% AAA-rated mortgage backed securities and US agency bonds, and municipal bonds on a tax-equivalent basis. These rates will not hang around indefinitely.

Postulating a Top?

The problem with cash is it has a tendency to burn a hole in one’s pocket, especially for institutional investors who are measured against the performance of indices. As time goes on and the Nasdaq and S&P500 continue to make all-time highs, eventually these cash holdings will begin to capitulate and buy, in spite of high valuations. This “I can’t take missing this anymore” mindset will set up a long term top. But in the meantime, significant further upside in stocks is very possible especially if the Fed begins to lower interest rates.

Much of the sidelined cash is hoping for a meaningful correction in stocks to jump back in, as the anguish of missing out in the steady rise of stocks tweaks the emotions of more and more investors. Usually when a market is heavily weighted to buy a dip, the hoped-for-dip doesn’t materialize. At some point, investors close their eyes and put that cash to work in stocks. And that is historically when a top in stocks will occur.

We noted in several prior Commentaries that we are solidly in a long-term, secular bull market in stocks. The artificial-intelligence ("AI") boom that started last year continues to drive the equity markets forward, hence the significant outperformance of the Nasdaq 100 index versus the S&P 500, Dow Jones Industrials and especially the Russell 2000 and other small cap indices.

Until we get either Fed rate cuts, real economic weakness or a geopolitical event of some kind, bonds will stay in this 4.00-4.50% range and – coupled with the large sidelined cash coming into play – continue to fuel global stocks (US and international).

Keep Risk/Reward in Mind

All equity market positives aside, consider your risk/reward mix. The 6% rates available in mortgage backed securities and other select investment grade bonds offer a very nice cushion to buffer an inevitable stock market correction, or worse, an equities bear market. An investor gets a very solid return on investment while bonds arguably have a better upside picture than stocks at this time.

As portfolio manager John Hussman of Hussman Funds wisely noted recently:

“If your notion of passive investing doesn't allow for a realistic possibility of a market loss well in excess of 50%, or a decade or more in which the S&P 500 lags Treasury bills, you've not only decided to be a passive investor, you've decided to ignore history. So, whatever your discipline, examine your risk exposures.”

At Atlas Financial Advisors our portfolio managers brings decades of experience in finding value, especially in the fixed income markets. We would be happy to provide you recommendations on how to better balance your investment risk while still achieving excellent returns.

We wish you all Happy 4th of July!

The Atlas Financial Investment Team

For further information on how Atlas Financial Advisors can help with your investment goals, contact us at info@atlasfas.com, or call (703) 980-7038 or (561) 704-0400.

Disclaimer

Observations and views expressed herein may be changed by the personnel at any time without notice. This document is not to be reproduced, in whole or part, without the written consent of Atlas.

June 2024 Market Outlook

As Go Rates…

As we enter summertime, it’s useful to remind ourselves that interest rates drive economies, currencies, and equity markets to a major degree. As May closed, the US interest rate picture was shown to be continuing a largely sideways pattern (with a bit of volatility thrown in!) ever since the Federal Reserve stopped raising rates in July 2023. The Fed Funds rate remains at 5.25-50% and the 10-year US Treasury note has been stuck between approximately 4.00-4.60% for most of the last year.

Chart 1: US-10-yr Treasury note chart (Source: Macrotrends)

With the Fed’s preferred Personal Consumption Expenditures (PCE) inflation gauge stuck around 3% for the last several months, Fed Chair Powell has been patently clear that the Fed won’t be cutting rates until more significant progress is made toward its 2% inflation goal.

Though rates rose to break out of a 40-year downtrend in early 2023 (Chart 2), it has settled into a 4-5% interest rate environment. Historically this level of interest rates has provided ample fuel for the US economy to grow, and for assets like equities to rise in price. Some meaningful catalyst will be required (e.g., global conflict expansion, widescale cyber security breakdown or myriad other possibilities) to cause a sustained breakout above or below this 4-5% range of stability.

Chart 2: 10-yr US Treasury Note over 50-years (Source: Macrotrends)

In the meantime, bonds offer excellent value. Stocks on the other hand are overvalued, but with $6 trillion in cash sitting on the sidelines and overall company earnings and employment remaining steady, the equity markets can continue to grind higher. But strap in for some choppiness. The optimism that got stocks to current levels is showing signs of wavering.

Opportunities in the Bond Markets

As a result of the “higher for longer” interest rate environment, in our opinion specific classes of bonds continue to offer excellent value in terms of risk and return. Bonds today make sense not only for Baby Boomers moving into retirement, but also for younger generations X,Y & Z as a central, stable piece of their investment portfolios.

Managers who actually understand individual bonds and fixed income asset classes, as well as where to find value on the yield curve, are an increasingly rare commodity. But this expertise has a reward, as these managers’ portfolios should continue to outperform bond ETFs and indices by a substantial margin.

To be specific, for the last year the bond market has provided managers and investors that understand these factors a steady diet of 6% and higher AAA-rated mortgage backed securities, US agencies, and select investment grade corporate and municipal securities. Average duration for these value trades mostly have been in 1-3 year maturities but also at points further out on the yield curve (5-12 years) at opportunistic moments.

These investments have afforded a tremendous anchor to individual and institutional investment portfolios. And with stocks pressing further into “strongly overvalued” territory (see Chart 3), increasing the percentage of these bonds in the overall construction of an investment portfolio makes a lot of sense to us.

Chart 3: The Buffett Indicator calculates the ratio of the total US stock market to GDP.
Source: Current Market Valuation

Equities

With static interest rates, relative economic stability and nothing igniting (yet) in the global risk powder keg, stocks will likely continue to grind higher in spite of high valuations. However, we noted in May that the pricing action appears to be forming a longer term top.

The technical picture shows the S&P, Dow and Nasdaq still in an uptrend that began in October 2023 but some divergence between price and relative strength is now occurring. New highs and lower relative strength indices can be a harbinger of at least a near-term top in the market. Further, the Dow has broken below its 50-day moving average while the S&P and Nasdaq recently bounced off and are trying to hold their 50-day average.

Chart 4 below compares the Nasdaq 100 (multi-color line), S&P500 (purple line), Dow Jones Industrial (blue line), and the Russell 2000 index (pink line). Chart 4 is as of the 5/31 close.

Chart 4

From the early 2022 stock market highs, here’s where we are today:

Nasdaq +22%

S&P500 +11.5%

Dow Jones +5%

Russell 2000 – 15.5%

Apart from the Nasdaq and especially Fab 5 tech stock performance, the rest of the market has had only moderate improvement over the last 2 years. Small caps never did recapture the 2022 highs.

Where to Find Value in Equities?

Of these 4 indices, the Russell 2000 (small cap stocks) represents the best relative value at present. Price/Earnings ratios are high for all 4 indices, though not egregiously so. Historically, small caps have outperformed large caps over a 50+ year period. But over the last 16 years small cap stocks have lagged their mid and large cap brethren, and especially since the October 2023 market lows. Small cap debt loads and ongoing uncertainty on whether the US economy will enter a recession have weighed on their performance. But this sector appears to be starting to close the gap, at least on a technical basis. Of course, small caps have a riskier profile but some rotation out of Nasdaq and into Russell 2000 can be justified at this juncture.

Another equity market sector of relative value is Emerging Markets (EM). EM, and especially China, have lagged the US, Japan and mid/large Euro stocks for several years now. But more recently EM has gone up approximately 18% over the last 12-months so it has regained some ground. The MSCI Emerging Markets Index (ex-China) only recently touched its 2022 highs, briefly, before coming off slightly (see Chart 5).

Chart 5: MSCI-ex China and iShares EM performance (Source: Blackrock)

China on the other hand is down approximately 40% from its 2021 highs and likewise has started to recover lost ground, but only in the last few months (see Chart 6). China has serious problems in real estate, under-employment among youth and a host of other issues. But much of the negative data is priced in at this point (sans an invasion of Taiwan).

Chart 6: China composite (Source: Blackrock)

Equities Big Picture

Though we see relative value in these few sectors, with respect to overall strategy we noted last month that it appears we may be in the process of making a protracted top in stocks, and that taking some profits on the way up would seem a prudent strategy. We still believe this makes sense for investors heavily invested in stocks (i.e., 65% or more), especially with the 6% yields we are able to find in the fixed income markets. We believe this is a sound adjustment in terms of risk and reward.

Global Risk Barometer

Lastly, the global risk picture feels like it’s hanging on a shoestring. The Middle East remains a powder keg with no apparent movement toward a resolution of the Israeli-Gaza-Hamas conflict. Ukraine is being slowly drained of weapons, supplies and manpower as Russia relentlessly pushes for more territory. In response, European border nations are ratcheting up their defense spending.

West and Central European Defense Spending (Source: Macrotrends)

To further shake investor confidence, China continues to present a burgeoning economic and military threat to US and western powers’ interests, and their ability to respond to conflict on a global scale. China’s expansion of its military presence in the Asia Pacific, saber rattling over a potential invasion of Taiwan, and cyber security and trade secret threats are just further fuel to rising global instability.

With this in consideration, maintaining a longer term perspective on investing is a helpful mental safeguard. Combining this with our risk hedges of a meaningful allocation to bonds and a smaller allocation to bitcoin, as we have recommended for months now, gives us much more peace of mind during periods of uncertainty like we are in today.

For further information on how Atlas Financial Advisors can help with your investment goals, contact us at info@atlasfas.com, or call (703) 980-7038 or (561) 704-0400.

Disclaimer

Observations and views expressed herein may be changed by the personnel at any time without notice. This document is not to be reproduced, in whole or part, without the written consent of Atlas.

May 2024 Market Outlook

Weakening Signs?

The first hint of labor market deceleration we’ve had for some time appeared in last Friday’s employment report. It showed the economy added 175,000 jobs in April, a sharp drop from 315,000 in March. The unemployment rate rose to 3.9%, up 0.1%, though still holding the 3.7-3.9% range it’s been in since August 2023. Leisure and hospitality were hardest hit with 5,000 jobs added in April versus 53,000 added in March.

Average hourly earnings (wage growth) fell to 3.9% vs. 4.1% in March. Wage growth has declined steadily from a high of about 6% in April 2022. The Fed is in a difficult position though, managing to lower inflation while this wage growth rate remains quite high. Hence their conclusion last week to leave rates unchanged.

US Average Hourly Earnings YoY – source Bureau of Labor Statistics

Another weak number came out Friday with the Institute for Supply Management (ISM) survey for April. The survey reported service-sector activity falling into contraction territory for the first time in 15-months. This survey tracks employment, new orders and business activity trends. Services is the largest segment of US economic production so this survey is an important gauge of economic health.

In the face of these weakening indicators, personal consumption expenditures (PCE) showed continued strength, rising in March to 2.7% from 2.5%, and eliciting cries that inflation is not only stalling out but may in fact be rising. We think that is a premature conclusion. These cries are from many of the same economists that made rosy Q1 forecasts of 3-6 rate cuts in 2024. Most forecasters have now faded their prognostications to 1 or 2 cuts and some are declaring the next Federal Reserve move is a rate hike. This tells us something about the accuracy of big bank and broker dealer forecasts (i.e., they’re usually wrong and often by a wide margin, as in this case). We were skeptical of those calls back then and are equally skeptical of pending rate hikes now.

US PCE Price Index YoY – source Bureau of Economic Analysis

In our simple view, inflation has come down steadily from its pandemic high but at this point is proving, unsurprisingly, sticky. As such, it’s only a matter of time before consumers pull back spending more significantly if wages continue to stall. The cost of basic goods and services is frustratingly high for most Americans. Consumer spending is by far the biggest driver of the US economy, representing nearly 68% of GDP in Q1 2024 according to the Bureau of Economic Analysis. So a moderation in consumer spending and subsequent recessionary rumblings would not be surprising.

The Fed doesn’t need to make any rate changes while we continue to have fairly stable growth and inflation numbers. We previously pointed out that, historically, the US economy has grown just fine with interest rates around 5%. The Fed announced Wednesday that they will keep the Fed Funds rate unchanged but slow down the reduction of their balance sheet. This simply means it has another tool in its arsenal to keep liquidity in the banking system and continue fueling the economy, without making rate changes. The stock and bond markets liked that announcement. Stocks bounced back from a recent modest 5% pullback and 10-year US Treasuries dropped from 4.65% to 4.50%.

In line with this rebound, Barron’s Big Money Poll came out this weekend showing “52% of poll respondents said they were bullish about the outlook for stocks over the next 12 months, up from 38% last fall, with another 33% describing themselves as neutral. About 15% said they were bearish, down from 24% last fall.” So the investment “pros” remain confident that the horizon is pretty much blue skies.

We are a bit more cautious about the future. We like the near-term market outlook and agree stocks can rally further, especially given the nearly $6 trillion cash on the sidelines. But looking beyond the short term we believe the stock market is in the process of creating a long term top that potentially could peak this year. We would not be surprised if the global equity markets enter a real bear market in 2024. Some reasons are as follows:

The US market has priced in high equity valuations (see the Buffet Indicator Model below), and the expectation that corporate earnings will continue to grow unabated. There are precious few calls for a recession while, at the same time, huge expectations that Artificial Intelligence (AI) will be the catalyst that cures all ills. We think this needs a healthy dose of discounting.

Rising global tensions put the US in a tenuous position as the dominant power to counter threats from Russia, China, Iran and the Middle East among others. These threats pose the possibility of both armed conflict across multiple regions, and technology threats targeted at crippling the US in government and corporate sectors wherever possible. As an example, ransomware attacks worldwide rose an estimated 74% in the past year according to a recent report by the National Intelligence Agency. The US is not well positioned to be the global cop anymore and public support of this role is fragile at best.
National unrest, US political polarization, a divisive presidential election this year, and the rising threat to personal liberties in our nation may not serve as triggers to a turn in the markets but certainly can add fuel to one.

The following table from the Global Economic Forum lists these and other risks that are top of mind to analysts around the globe:

In summary, we think it prudent to consider that some of these concerns will manifest this year, though of course we would be glad if somehow they can be averted. As a result, we advise using caution in investing by making sure high-rated fixed income securities (government and investment grade credits) comprise a significant percentage of investable assets, and that equities holdings get progressively reduced as the stock market rises further. Percentages vary based on individual circumstances and we would be happy to provide some direction on that. But big picture, taking money off the table sometimes can be good medicine.

In bonds, we continue to find yields above 6% in US government guaranteed mortgage back securities. We believe these represent excellent value. In US government agency and high grade corporate bonds we are finding yields at or close to 6% in 1-3 year maturities. Sprinkling in longer dated maturities (7-12 year) also continues to make sense whenever a brief rise in interest rates occurs, which of late is often.

Markets recap (April 1 – May 3):

- US Equities -1.0% (SPX, DJX, NDX average)

- Bonds -0.34% (GVI Short Intermediate Bond Fund)

- Bitcoin -11.0% (GTBC ETF)

- Energy -2.67% (XLE ETF)

- Metals +4.21% (GLD and SLV ETFs)

- Agriculture averaged -2.09% (GLG and VEGI ETFs)

As ever, contact us at info@atlasfas.com if you have investing questions or needs, or call (703) 980-7038 or (561) 704-0400.

Good investing!

Disclaimer

Observations and views expressed herein may be changed by the personnel at any time without notice. This document is not to be reproduced, in whole or part, without the written consent of Atlas.

April 2024 Market Outlook

A Tale of Two Markets: Strong Economy, Sticky Inflation

We begin April and springtime with US debt, equity and currency markets focused heavily on when the Fed will cut rates, having seen Wall Street economists at every wire house progressively trim their estimated number of rate cuts for 2024. The sticky inflation and employment data of the past few months gives good reason for some tempered enthusiasm. Interestingly, there is virtually no discussion or expectation that the Fed might not cut rates at all this year. I find this puzzling given some of Fed Chair Powell’s comments. After the recent PCE numbers Powell noted that “we don't see it as likely to be appropriate that we would begin to reduce interest rates until the Federal Open Market Committee is confident that inflation is moving down to 2% on a sustained basis,” noting that the Fed would need to see "more good inflation readings like the ones we were getting last year." With the US economy still growing steadily and employment remaining strong, getting numbers like last year is no small order.

In terms of positives for the US economy, however, here are a few points to consider:

Unemployment has remained fairly close to its historic low (current 3.9% vs. Jan 2023 low of 3.4%) in spite of 11 increases in the Fed Funds rate from March 2022 to July 2023
Job openings are still significantly higher than pre-pandemic levels (26% above, according to an Indeed data report)
US consumer spending has grown steadily over the past year, accounting for 68% of our nation’s GDP as of the end of 2023
In February 2024, consumer spending rose 0.8%, the largest gain since March 2023, indicating there has been little pullback in spending in spite of the fairly painful rise in the cost of goods, services and housing over the last year plus
US home sales jumped 9.5% in February and the median existing home price rose 5.7% over the last year (good news for homeowners, at least… not so good for buyers)
Fed data shows wealth among the bottom half of US families rose by almost 75% since the first quarter of 2020, and remains strong
Small businesses, which are responsible for nearly two-thirds of all new job postings, continue to show strong demand for labor as new-business applications rose 34% from 2021 to 2023 and are up since the start of 2024
Labor force participation (working-age population either working or looking for work) has remained steady at 62.5%, unchanged from a year ago

If interest rates continue to hold in a range between 4.0-4.5% on the 10-year US Treasury note, then continued solid economic data can provide further fuel for equities markets to rise and indeed to broaden out to more stocks than the short list that benefited from the rally in 2023.

But it’s not all roses out there. Some darker clouds to consider:

Real wages are falling (the amount people are paid when adjusted for inflation)
- While nominal wages have risen by around 10% since Biden took office in January 2021, overall prices have increased 14% resulting in a net wages loss of 4%; further, the decline in real wages has hit virtually every major sector of the economy, meaning Americans are working more hours for less pay and retirees are getting less for their hard earned savings
Housing affordability has worsened significantly; the median mortgage is twice that of 2013 and has increased $1400 since 2020, while affordability is 40% worse than 2022
Median home prices are now 6 times median income vs. 4-5x 20 years ago, while the ratio of rent to median income has risen 25-30% over the last 2 decades (Econofact article “Hitting Home: Housing Affordability in the US”, 3/14/24)
US household debt is at an all-time high of $17.3 trillion (this includes home mortgages, home equity loans, auto loans, credit cards, student loans and retail cards), and consumers have registered negative savings for the last 5 quarters
The Consumer Expectations Index has fallen below 80 (March @73.8; 1985=100), which historically is associated with a forthcoming recession
Average childcare costs are up 32% since 2019, which doesn’t include the effect of pandemic-era funding that ran out last September (i.e., costs should rise further)
Auto loan delinquencies hit a 13-yr high in Q4 2023 at 7.7% (no 2024 data yet)
The US personal savings rate fell to 3.8% in January vs. the long term average of 8.48%
The commercial office vacancy rate of 19.6% is the highest since at least 1979 (WSJ 1/8/24)

And of course, geopolitical threats in Europe, Asia and the Middle East haven’t budged, US debt continues to balloon to unsustainable levels, and US political division is just starting to ramp up to new heights with the 2024 elections.

So what does this portend for the bond and stock markets and how should we position investments?

Bonds

Bonds continue to provide value and good risk mitigation for diversified investment portfolios. With the stall in the Q4 2023 bond market rally, and modest back up in 10-year rates from 4% to 4.30%, we have been able to increase holdings in AAA-rated, monthly-pay mortgage backed securities at 6% yield and higher, AA and AAA rated municipal bonds with taxable-equivalent yields above 6% (10-year and longer maturities), and investment grade corporate bonds with yields between 5.50-6%. Coupling these investments with a smaller holding of US T-bills and money market funds – instruments that offer yields around 5.25% along with high liquidity for when more compelling investment opportunities arise - the fixed income space is rightly earning larger percentages of professionally managed portfolios. Predictable income at rates we haven’t seen for over 15 years continue to underscore the value of having a meaningful percentage of assets in these securities. Remember the rule of 72: your money at a fixed annual rate of 6% doubles in 12-years, and slightly over 10-years at a 7% rate (divide 72 by the fixed rate of return to get the number of years for your initial investment to double). We have been investing in bonds at 6% to 7% since last October.

Stocks

The up-trend in both US and major international market equities continues with the S&P 500 up 10.2% for the first quarter of 2024. Barron’s weekly noted that the index has gained over 8% in the first quarter of a year only 16 times since 1950. In 15 of the 16 times the index gained an average of 9.7% in the following 3 quarters of the year (the 1987 crash being the exception where it lost money after the first quarter). The takeaway is a start like we have had in 2024 has over a 90% likelihood to gain further ground the rest of the year, barring a black swan event which isn’t out of reach given geopolitical uncertainty and US political and social disfunction.

It’s also worth noting, however, that all 3 major indices have begun to lose momentum. This is why we recommended last month to shift a portion of equity allocations to fixed income, commodities and bitcoin (bitcoin we have been recommending to have a small percentage of since last fall). Given the unabated rise in the S&P from 4100 last October to over 5200 today, the potential for a 10% pullback to around 4600 isn’t unreasonable. This doesn’t mean the current secular bull trend has broken down. From the October 2022 low of about 3500 we had 3 sharp pullbacks of -8.1%, -9.4% and -10.4% on the way to the current all-time highs. We would need to see a string of weaker economic numbers to give credence to a top in the equities markets.

How did our March Outlook suggestions do?

We recommended lowering equities holdings to 45% for those with over 50%, and increasing fixed income to 45%. We also suggested having 5% in bitcoin and 5% in commodities (by commodities I mean energy, metals and agriculture ETFs). Here are some indicative figures, as of last night’s close (4/1/24):

The 3 major indices (SPX, DJX, NDX) averaged +1.24%
I-Shares short/intermediate/long bond ETFs averaged -0.80%*
Bitcoin gained +14.52%
Energy (XLE ETF) gained +8.90%
Metals (GLD & SLV ETFs) averaged +5.3%
Agriculture (VEGI & GSG ETFs) averaged +2.52%

*Note: Atlas does not invest in bond ETFs, rather individual bonds where we are able to find higher yields than ETF averages, offering us the opportunity for outperformance vs. bond indices. We like the cushion our fixed rate returns provide to overall portfolios.

We wish you good investing and contact us if you have any questions or comments at info@atlasfas.com, or call us at (561) 704-0400.

Disclaimer

Observations and views expressed herein may be changed by the personnel at any time without notice. This document is not to be reproduced, in whole or part, without the written consent of Atlas.

March 2024 Market Outlook

This month we are providing a Summary of our Market Outlook for those interested in the Reader’s Digest version, followed by further drill-down for those that want to dive deeper. We hope this fits all and we welcome your feedback.

Summary

With the rising confirmation that the Federal Reserve is not cutting rates anytime soon, and that the cuts will be fewer than the market previously baked in, some equities caution and an increase in bond allocations is merited. We have to chuckle at how nearly every major brokerage house has back peddled on their forecasts and removed multiple rate cuts from their prognostications. We didn’t buy the rosy rate cut forecasts back in November and we still believe they will be less the market expects.

With the recent significant run-up in stocks and small backup in interest rates, we recommend shifting asset weightings with a tilt more to bonds, especially for those with a 60/40 or higher stocks-to-bonds allocation. The secular bull market in stocks is still intact. But a pullback and consolidation is warranted. With market breadth now expanding beyond the Magnificent-7 we look at this as an opportunity to take some gains and buy back on dips. But choppiness in equities markets will likely reign for some time given the outsized stock gains of 2023 and increased caution on interest rate cuts. Bonds still represent excellent long term value, if you know where to look. Hence our recommendation to increase this holding percentage.

For those with a 60/40 or higher equities ratio in their portfolio, we recommend shifting to a 50/50 allocation (stocks/bonds) or just increasing cash that currently pays above 5%. We think a couple of other sectors are advisable as well for additional diversification (see allocations, below). US small cap (e.g., Russell index) and international stocks are beginning to catch up to the major US indices and we believe these will continue to gain relative ground. A modest portion of your equities holdings in these sectors is merited.

In Bonds, value continues in mortgage backed securities where we still are able to find yields of 6-6.25% for AAA-rated securities. These bonds are a great way to add a relatively high and stable return to an investment portfolio. When we first started recommending MBS bonds last year the yields were 6.5-7% and above. At 6-6.25%, they are still an excellent investment.

US agency bonds (AAA) also offer 6% yields in 5-year maturities with a non-callable provision for 1-year. Lower investment grade corporate bonds with several years call-protection are also available at 6% and higher yield, and mainly AA-rated (some AAA) municipals in 5-10 year maturities are offered at over 6% taxable equivalent yield.

Commodities have been stuck in a narrow sideways range for the last year and a half, after a 30% drop from the early 2022 supply-chain bottleneck peak. The divergence between stocks and commodities has reached one of the widest gaps in history, with the S&P 500 at the top of its 2-year range and commodity indices near the bottom. A modest allocation to a broad commodities ETF makes sense for risk diversification and value, especially where a meaningful dividend or carry yield can be had. The iShares Commodity Curve Carry Strategy ETF (CCRV) is a way to participate in 10 different commodities via the futures market. This ETF’s performance since inception has been solid and it’s current yield is above 7%. For details see https://www.ishares.com/us/products/310784/ishares-commodity-curve-carry-strategy-etf-fund.

Lastly, for a number of months we have recommended having some allocation in Bitcoin. We continue to believe this is a good diversification strategy even with the recent run-up in price, though we recommend waiting for a lower entry point on a pullback. Bitcoin wallets are now in the millions and likely will continue to grow, structural support continues to strengthen, and with a finite number of coins (as opposed to the limitless printing of fiat currencies) Bitcoin represents diversification with the potential for outsized gains on a small allocation.

Periodic portfolio adjustments are part of a successful investment management strategy to reflect changes in market value, inflation, global economies and geopolitical events. Based on the observations above, we deem the following allocations to be a prudent example of diversification, growth and value at this time:

· 45% stocks (across US and International index ETFs)

· 45% bonds (across MBS, corporate and muni securities, with concentration in MBS)

· 5% Bitcoin (via a wallet or Grayscale ETHE ETF)

· 5% commodities indices (ETFs)

A tweak of this to 40% stocks – and moving the incremental 5% to cash which continues to pay an attractive rate of 5-5.25% - diversifies risk a bit further and provides dry powder to buy back into stocks on a pullback. Of course, individual financial needs and circumstances vary and need to be incorporated in any investment planning.

Atlas is able to help you assess your current portfolio allocations and make adjustments to align with your investment and personal goals. Reach out to us if you would like to discuss how we can assist you in your long term financial planning.

Other Takeaways

Labor Supply and GDP

Labor supply has remained strong and continues to be a driver for US economic growth, prompting a number of economists to revise upward their GDP forecasts for 2024. Strong participation rates and especially a huge increase in international migration over the last two years has been a key driver of growth in the labor force. Stickiness of labor costs will keep pressure on headline and core Personal Consumption Expenditures (PCE), slowing the rate of decline to the Fed’s 2% target and prompting a slower rate cut schedule than previously thought. Prior expectations for a March cut have slid to June, which still may be too optimistic (Fed member Bostic recently stated he didn’t expect to see any cuts until September).

US Equities Technicals

Stocks declined today with the Nasdaq overall, and Magnificent-7 in particular, leading the way down. After the heady rise from the early January lows of around 4700 to 5100 on the S&P 500 last week, a pullback is more than warranted.

Support on the S&P 500 is now at 4700 and then 4300, and we expect at least 4700 to be reached.

Are we in a Stock Market Bubble?

Though exuberant for the last several weeks, the stock market does not appear to be in a bubble. Rather just a top after an amazingly resilient run up from last October that took out just about every bear in the market. Ray Dalio offers an interesting commentary in his recent LinkedIn newsletter titled “Are we in a stock market bubble?”. His bubble gauge considers value, sustainability of growth rates, impact of new and naïve buyers, bullish sentiment, percentage of purchases paid with debt, and forward purchases based on a price gain bet. His conclusion? The stock market “doesn’t look very bubbly” even at these all-time highs.

The Case for Higher Stocks One-Year Out

With respect to what has happened to stocks following hitting new all-time highs, a fellow advisor shared some insights from Warren Pies of 3Fourteen Research that are worth noting:

First, since 1954, stocks were higher 93% of the time (14 out of 15) one year after the stock market made an all-time high. The one exception was 2007 when the housing bubble burst, subprime mortgages were defaulting, and the great financial crisis was about to start. As he states, “Do we have conditions in 2024 like conditions in 2007? No, at least not yet.” But past events don’t ensure a repeat either.

Second, rates of return one year after a new high all-time high ranged from +4.9% to +36.9%. In addition, drawdowns (market retracements) were shallower over that next year.

These data points make the case for staying invested in stocks on a long term basis, and having a plan to buy back in if you take profits at these levels.

Market Sentiment

The CNN Fear and Greed Index is back in Extreme Greed territory. It seems like just yesterday that we shared the index reading of Extreme Fear (November 2023). How quickly sentiment can swing! But this gauge continues to be helpful in identifying extremes that merit at least modest portfolio adjustments.

US Dollar & Geopolitics

Lastly, the US dollar recently has been buoyed by a weakening European economy and increasing possibility of lower rates there. Long term, however, the US dollar remains in a precarious position if the US government outstanding debt is not lowered. We discussed this at length in prior Outlooks but the key markers have not changed:

· Total debt: $34.4 trillion

· Debt as % of GDP: 123%

· Rising debt financing costs at current higher rates

· Inability of a polarized government to reduce spending

According to Trading Economics, the US debt rises approximately $1 trillion every 100 days! This is astounding. Debt as a percentage of GDP hit an all-time high of 133% at the end of 2023 and has declined slightly in Q1 thanks to GDP growth. But this time bomb has to be dealt with in stringent ways that Congress has not demonstrated the backbone for in many years now.

Coupling US political polarization with continued threats from Russia and China, and a growing humanitarian crisis in the middle east, we have no shortage of fuel to quickly change market stability. On that note, we adjourn until next month. Good investing and contact us if you have any questions or comments at info@atlasfas.com.

Disclaimer

Observations and views expressed herein may be changed by the personnel at any time without notice. This document is not to be reproduced, in whole or part, without the written consent of Atlas.

Special Report - October 2024

Valuation Warnings

Similarities of the Decades 1999-2009 and 2014-2024

Other Pressures to Consider

Are There Any Positives Out There?

Where Does this Leave Us?

September 2024 Planning Insights

Strategies for Reducing Taxes on Required Minimum Distributions (RMDs)

Minimizing RMDs

Should I convert my IRA to a ROTH?

So why consider converting to a ROTH?

August 2024 Market Outlook

Bonds Now Outperform Stocks

Stock and Bond Returns Over Several Time Periods

July 2024 Market Outlook

June 2024 Market Outlook

May 2024 Market Outlook

Weakening Signs?

April 2024 Market Outlook

A Tale of Two Markets: Strong Economy, Sticky Inflation

So what does this portend for the bond and stock markets and how should we position investments?

March 2024 Market Outlook

Summary

Other Takeaways

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