Acumen's Market Insights & Commentaries

Macroeconomic Outlook – The Covid-19 pandemic and resulting economic shutdown quickly threw the global economy into a deep recession. Within a very short period, economic growth was in a steep decline, business and consumer confidence was at all-time lows, and we faced a steep deflationary environment. Monetary and fiscal policy authorities deployed massive accommodative policies to help bridge the economic gap to a post-Covid world, and we quickly started a new economic recovery. We do not want to continuously rehash the events that unfolded in 2020 and 2021, but we believe it is important to understand the transition from one stage of the economic cycle to another which happened quicker than normal. We think this is an incredibly important factor to note as, looking forward, we believe we are once again likely to be looking towards a transition in the economic cycle during the next 12 to 24 months – from Mid to Late cycle.

Leading Economic Indicators – These indicators continue to point towards positive economic growth over the next 12 to 18 months. The Conference Board’s Leading Economic Index, a basket of ten economic data points that tend to lead changes in the economic cycle, has exhibited positive month over month growth for the 19^th time in a row. However, the pace of growth in major leading economic indicators is beginning to slow across various time horizons. So, we are experiencing higher than average economic growth with a slowing pace. To us, this points to being Mid Cycle and likely transitioning towards Late Cycle in the next 12 to 18 months.
Policy – A key theme for 2022 will be a less accommodative monetary policy. The Federal Reserve is coming off almost two years of implementing historically ultra-supportive policies. Interest rates have been set at 0% since March of 2020 and the Fed more than doubled the size of their balance sheet in hopes to provide liquidity to financial markets. These policy decisions allowed for quicker than expected recoveries in both the economy and in the labor market. All the stimulus has also led to higher-than-expected inflation. Due to the rise in inflation, the Fed must react by switching from ultra-accommodative policies to more restive ones in hopes to safely slow the pace of the economy. To combat inflation, the Fed plans to raise interest rates at least three times in 2022 and is even considering selling assets from its balance sheet, a task the Fed calls “balance sheet normalization”. Raising interest rates and shrinking its balance sheet will be a top concern for the Fed, but they must implement these policies carefully, as switching from an accommodation stance to a more restrictive one, can be a daunting task. If the Fed moves too quickly, they run the risk of throwing the U.S. into a recession. If they move too slowly, inflation, over time, can eat away real purchasing power.
Inflation – Inflation is likely to once again be another polarizing factor for financial markets in 2022. The reopening of the global economy came at a unique time when there was a boom in demand created by pent up savings and never before seen monetary and fiscal stimulus measures, a broken supply chain caused by Covid-19 disruptions, and a falling labor force participation rate. The resulting imbalance between supply and demand caused inflation readings to produce the hottest numbers we have seen since the 1970s. Supply chain disruptions have shown signs of easing in recent months, but we believe we are in for higher-than-average inflation readings for the short-term because of labor imbalances. However, financial markets have likely priced in higher short-term price increases. The Two-Year Breakeven is currently just above 3% – indicating market participants are currently pricing in an inflation rate over the next two years of approximately 3%. What is interesting is longer-term readings of expected inflation are pricing in a much more moderate rate of inflation. For instance, the Five-Year Breakeven is closer to 2.75% and the Ten-Year Breakeven is around 2.5%. Not only are these measures of longer-term inflation expectations closer to the Fed’s 2% target, but they have all exhibited downward pressure since the beginning of 4Q 2021 – a result of what we believe is a longer-term disinflationary trend. In the decade leading up to the Covid-19 pandemic, central banks struggled to reach inflation targets as an aging demographic and the greater adoption of technology provided a deflationary headwind. We believe the pandemic will exacerbate these trends in the long term, but the supply imbalance caused by labor shortages will keep price changes higher than what we have grown accustomed. This imbalance is likely the factor we are watching most in 2022. But, as of right now, we do not believe we will reach the level of inflation seen in the 1970s many investors have been weary of late.

Equity Market Outlook

Source: Bloomberg. Data as of December 31, 2021

2021 was a year of resilience for equity markets. Amidst some of the highest uncertainty, we have seen since 2008, major equity indexes posted strong returns with the exception of Emerging Markets. For the third year in a row, the S&P 500 climbed more than 15%. While 2020 generated large dispersion in returns between styles, sectors, and themes, 2021 saw a more united rise across approaches to equity investing. Our outlook for the next 12 to 18 months remains constructive for equities, but less so than recent periods. We believe relative valuations, the lack of alternatives, and an expected rise in profits point to long-term upside for equity prices. However, we are taking a more defensive approach to equity exposure as we mature in the economic cycle, monetary policy measures become more restrictive and absolute valuations remain very high. We delineate these viewpoints below in greater detail:

Our Macro Outlook is we are Mid Cycle. While economic growth is likely to remain high, the pace of the growth should slow as we get closer to full employment and closer to our pre-pandemic stage of trend growth. The primary point is equities are less likely to easily digest volatility as this happens. Equity prices climbed walls of worry created by uncertainty behind Covid, politics, and inflation as there was clear upside in terms of how high economic growth was expected to be.
Another key point of our Macro Outlook is the central bank policy is likely to become more restrictive. During 2020 and most of 2021, monetary policy across global central banks was incredibly expansionary and helped drive investors to spend more money and purchase financial assets. This policy framework began changing in late 2021 as the Fed started tapering the amount of assets being added to the balance sheet, and investors began pricing in a higher chance of interest rate hikes in the near term. This change to a more restrictive policy framework is important for a few reasons. Most importantly to stocks, the expansion of the Fed’s balance sheet and cutting of interest rates to near zero incentivized investors to pay a higher price (in terms of valuation) for stocks by being a source of liquidity and taking away the opportunity cost from other investments (bonds). This rate of change to a more restrictive policy framework is less constructive for equities moving forward.
When comparing current equity valuations to their average over the last two decades, they look expensive on almost every level. However, we have been large proponents of the idea high valuations do not necessarily create bear markets in stocks which led us to continue to be long equities in 2021 when the market continued to rise amid skepticism in how high valuations were. However, as the Fed’s policy becomes more restrictive, investors will be less willing to pay as high of a multiple for stocks, causing us to believe 2022 will likely be a year of multiple contraction. We remain constructive on stocks in the long-term as their relative valuation versus bonds remains attractive. Our preferred way to compare the valuations between stocks and bonds is the Equity Risk Premium, which compares the yield that a dollar of investor capital is generating in earnings to the yield investors, are receiving off popular bond investments. By this measure, stocks remain attractive in the long term. The chart below shows the Equity Risk Premium for the S&P 500 to the Ten-Year Treasury Yield, the 30-Year Treasury Yield, and the yield on investment grade corporate bonds.

Our outlook on valuations, described above, has a couple of important implications for equity portfolios. For one, we want portfolios to have equity exposure to companies that do not exhibit valuations detached from underlying fundamentals. 2020 and most of 2021 showed investors were very willing to pile into more speculative areas of the equity market. That trend began reversing in late 2021 and we believe it will continue to do so in 2022. We believe equity exposure should be positioned towards high quality companies whose earnings growth can generate positive returns amidst the multiple contraction we believe will come in the next 12 to 18 months.
Two other tilts we have within equity portfolios moving into 2022 is to be lower beta and higher exposure to international equities relative to target. Our decision to lower the beta of equity exposure comes as we believe higher speculation will continue to fall out of favor, and the broad equity market could move more sideways with multiple contraction and higher volatility. Our decision to overweight international stocks comes as the price investors are paying for International Equity exposure versus that of Domestic exposure has reached an all-time high. This trend in the valuation spread between the two exposures have been building for years, but we believe a tailwind finally exists in the international space to close this gap as major international economies are expected to have higher GDP growth and higher earnings growth than their long-term average. This upside is aided by the slower reopening in international economies post-Covid.

Fixed-Income Market Outlook

2021 was a historically bad year for bonds. The Ten-year Treasury yield ended the year up over 60 basis points. This yield was the biggest annual rise since 2013. Yields rose across the curve and especially at the short end. The Bloomberg Barclays Agg returned -1.61% in 2021. Our stance going in to 2021 was to be underweight fixed income due to low real yields, rising economic growth and inflation, and range-bound yields. Going into 2022, we expect to remain underweight fixed income.

A key to our fixed-income outlook is understanding the current shape of the yield curve and how it is expected to change going forward. The shape of the yield curve is determined by expectations on inflation, economic growth, and Fed policy changes. Throughout 2021, we saw the yield curve become flatter. Yields rose across the curve but rose more for shorter term bonds. We expect this trend to continue into 2022 and is a primary reason we are going into this year with a negative outlook on fixed income.
Federal Reserve policy is quickly becoming less accommodative. For the past two years, the Fed has provided financial markets with massive amounts of liquidity through quantitative easing and remained very accommodative by keeping interest rates anchored at 0%. This period of extreme accommodation is over. The Fed is now on pace to end quantitative easing by late March 2022 and is expected to raise interest rates quickly after. The consensus is the Fed will raise the federal funds rate at least three times in 2022. Along with raising interest rates, the Fed is also expected to begin quantitative tightening (the Fed selling government securities) sometime this year. This switch from easy, accommodative policy to restrictive policy will have a significant impact on financial markets.
While yields are expected to rise in 2022, with some expecting the yield on the Ten-Year Treasury to rise to 2.25-2.5%. We differ in this viewpoint and believe yields will remain low in the long-term as long-term inflation expectations are anchored near 2%, short-term inflation expectations are decelerating, and the Fed is expected to slow inflation even more. As yields do rise, we see this as an opportunity to extend duration and lock in higher yields. In terms of positions within fixed income, we favor high quality over low quality, and we prefer to not take on excess risk from bond positions. We expect slower economic growth and higher volatility going forward and having a tilt toward high quality can help protect portfolios during volatile periods. We also favor taking a bar-belled approach to duration to help take advantage of a flattening yield curve. A more bar-belled strategy involves concentrations in short- and long-dated securities. The allocation to longer dated securities allows us to average into higher yields over time while the allocation to short, dated securities helps reduce interest rate risk by reducing price sensitivity.
While we have been underweight in bonds for a while, and continue to be into 2022, we still believe bonds are essential to investment portfolios in the long term. Bonds offer diversification and capital preservation benefits are important to overall portfolio performance.

Asset Class Views

All indexes are unmanaged, and an individual cannot invest directly in an index. Index returns do not include fees or expenses.

The Conference Board Leading Economic Index® (LEI) for the U.S. – The composite economic indexes are the key elements in an analytic system designed to signal peaks and troughs in the business cycle. The leading, coincident, and lagging economic indexes are essentially composite averages of several individual leading, coincident, or lagging indicators. They are constructed to summarize and reveal common turning point patterns in economic data in a clearer and more convincing manner than any individual component – primarily because they smooth out some of the volatility of individual components.

The ten components of The Conference Board Leading Economic Index® for the U.S. include:

• Average weekly hours, manufacturing

• Average weekly initial claims for unemployment insurance

• Manufacturers’ new orders, consumer goods and materials

• ISM® Index of New Orders

• Manufacturers’ new orders, nondefense capital goods, excluding aircraft orders

• Building permits, new private housing units

• Stock prices, 500 common stocks

• Leading Credit Index™

• Interest rate spread, 10-year Treasury bonds less federal funds

• Average consumer expectations for business conditions

Gross Domestic Product (GDP) is the monetary value of all finished goods and services made within a country during a specific period.

The 10-year Treasury Yield is used as a proxy for mortgage rates. It’s also seen as a sign of investor sentiment about the economy.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada.

Fed Funds Rate is the interest rate U.S. banks charge each other to lend funds overnight

The velocity of money is a measure of the number of times that the average unit of currency is used to purchase goods and services within a given time period.

Any charts, graphs, and descriptions of investment and market history and performance contained herein are not a representation that such history or performance will continue in the future or that any investment scenario or performance will even be similar to such chart, graph, or description.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own financial professionals, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure they obtain all available relevant information before making any investment. Any forecast, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given, and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results. Diversification does not protect against loss of principal.

Acumen Wealth Advisors, LLC® is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Acumen Wealth Advisors, LLC® and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Acumen Wealth Advisors, LLC® unless a client service agreement is in place.

Debate continues in Washington over the proposed tax changes contained in the Build Back Better Act and the Bipartisan Infrastructure Bill. These tax proposals would raise the top marginal income tax rate from 37% to 39.6%. The increased top marginal rate, combined with the expanded 3.8% net investment income tax, would apply to active business income. In addition, a new 3% surcharge for high-income taxpayers with adjusted gross income above $2.5 million ($5 million for married couples) creates a maximum federal tax rate of 46.4%. The maximum capital gains tax rate would increase from 20% to 25%, but earlier the proposed rate was as high as 39.6%. While both proposals contain numerous provisions affecting both individuals and businesses, one key area under scrutiny in both proposals are Roth IRAs.

You may have seen news articles pointing out Peter Thiel’s $5 billion Roth IRA was originally funded with $2,000 worth of his initial PayPal shares. Coincidence or not, restrictions on Roth IRAs are very likely to be implemented under the current tax proposals. Wealthy savers won’t be allowed to contribute to Roth or traditional IRAs if the combined value of their defined contribution plans exceed $10 million in the prior year. This would apply to single individuals earning more than $400,000 or married joint filers earning more than $450,000. Furthermore, “back-door” Roth conversions of after-tax traditional IRA or 401(k) will be off limits for those earning more than $400,000 per year. Historically through “Mega-backdoor” Roth conversions, wage earners could contribute up to $58,000 in after-tax money to a 401(k), roll it into an IRA, and then make a Roth conversion. This process would be banned for everyone. “Backdoor” and “mega-backdoor” limitations would be banned starting in January 2022. All Roth conversions would be banned for high-income earners starting in 2032.

If the combined balance of an investor’s IRA, Roth IRA, 401(k) and other defined benefit plans exceeds $10 million, they would be required to distribute the excess balances. The new required minimum distribution (RMD) would be 50% of any amount over $10 million. An RMD of 100% would apply to any balance beyond $20 million. Mr. Thiel could be facing a rather large RMD with a 40% tax rate.

It is important to note the estate tax exemption is proposed to return to the pre-Tax Cuts and Jobs Act limit of $5 million in 2022. This exemption creates a significant estate tax issue for some who were not previously exposed to estate taxes under the higher estate tax exemption. With more estates being affected by estate tax, it is possible to avoid an estate tax trap using Roth accounts. Traditional IRAs are subject to estate tax and essentially taxed on an embedded income tax liability. To help illustrate this scenario, assume a $1 million traditional IRA is within an estate subject to estate tax. The $1 million traditional IRA would be subject to a 40% estate tax. However, when the $1 million is distributed to the beneficiaries, the distribution would be subject to ordinary income tax, potentially at 39.6%. The net cash after estate tax and ordinary income tax on $1,000,000 would only leave $204,000 remaining. If this $1 million traditional IRA was converted to a Roth IRA in 2021 and we assume the highest tax rate of 37%, the resulting Roth would be subject to estate tax, but not the ordinary income tax on distribution. While it’s never fun to pay a 37% tax rate, this strategy could generate $174,000 in tax savings as shown here:

Example Savings

Traditional IRA	$1,000,000	Roth IRA	$1,000,000
Cash outside of IRA	$370,000	Cash outside of IRA (After Tax on conversion)	$0
Estate Tax	($548,000)		($400,000)
Ordinary Income tax on distribution	($396,000)		$0
Net Cash	$426,000		$600,000

Savings

$174,000

There may be an extra incentive for 2021 Roth conversions even at higher ordinary income tax rates, especially for those with estate tax considerations. Keep in mind the tax proposals are still being negotiated. However, Roth conversions and the estate tax exemption are both known points of scrutiny.

This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. The information has been obtained from sources we believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.

During the last 18 months, we have become accustomed to pessimistic narratives. And, while the third quarter of this year didn’t include a new pandemic, revived social unrest, or Prince Harry and Meghan Markle leaving the royal family, the NUMBER of pessimistic narratives surrounding the third quarter was significant. Volatility across foreign policy, the Delta wave, supply shortages, and the debt ceiling debate, all contributed to a stock market (S&P 500) that was up approximately a half of a percent and a bond market (Bloomberg Barclays U.S. Agg) that was flat in the third quarter. While a look at the third quarter might provide a negative view for financial markets volatility was actually introduced in September as the S&P 500 fell more than 4% during the month. However, we are reminded there was an average drawdown of close to 14% every year since 1980 in the S&P 500 [1], and we believe the bull market, started on March 23^rd of 2020, is still intact. Below, we outline our view on major topics surrounding financial markets today.

Economic Growth

One variable, used to help construct our outlook on future economic growth, is leading economic indicators. Leading indicators are economic datapoints tending to move before major changes in the business cycle. Changes in the business cycle can have drastic implications for how we allocate assets. We like to use a basket of leading indicators constructed by the Conference Board – the Leading Economic Index (LEI). The LEI has continued to advance and continues to create a constructive outlook for economic growth. However, one important point we believe should be noted is the upward rate of change has begun to slow. This change causes us to believe we could be transitioning from an early expansion phase of the business cycle to a more mature phase of the business cycle. Other indicators of economic growth support this view as well. While we believe the level of economic growth will continue to increase, there is evidence the rate of change will slow over the next 12 to 18 months. This slowdown/decrease has implications on our asset allocation. With the transition of the business cycle from an early expansion to mature, the market will typically not be able to digest volatility as well. But we typically do not see sustained bear markets without a transition in the business cycle from a period of growth to a period of decline.

Inflation

The original catalyst for the idea of higher inflation was the increase in government deficits across most major economies driven by large amounts of stimulus. At the same time, the Federal Reserve changed its policy framework to allow for higher inflation in the short-term. This unfamiliar policy shift, coupled with the idea that pent up demand would cause supply bottlenecks, caused inflation to become the most hotly debated topic amongst investors and economists. While we believed supply chain disruptions would cause short- to medium-term higher inflation, we adhered to the idea high inflation would not become a structural problem. Current inflation readings have been higher than the long-term average, as we have seen major supply chain disruptions. We believe a few reasons for the disruptions across supply chains are the reliance on Just in Time inventory, a greater need on a globalized supply chain in today’s world, and the labor market dynamics of higher unemployment as demand has surged post Covid lockdowns. Our opinion remains that these pressures will subside as labor market dynamics heal and the surge in demand subsides. Our long-term view remains; there are too many structural headwinds to higher inflation – two of which are aging demographics across major economies and the further adoption of technology in the modern economy. However, we believe the most important factor causing inflation to be transitory is recent history telling us higher government deficits are a drag on growth and, as a result, inflation. While higher debt and stimulus may provide a sugar high for a moment, the long-term effects have been largely disinflationary. We believe inflation cannot become a long-term factor unless we see the Velocity of Money increase – the measurement of the rate at which money is exchanged in an economy. This variable has been falling for years as banks have been disincentivized to lend more capital. This relationship can be seen from the deviation in loans and deposits in major banks. While headline inflation readings have risen to their highest levels in over a decade, we have started to see them begin to cool over the previous two months. We have some tactical allocations to asset classes that do better in an inflationary environment, but our long-term outlook for inflation has kept us from changing portfolio allocations in a sizable way to be geared more toward a higher inflationary environment.

Asset Class Views

After a more volatile third quarter, major stock indices are still up more than 10% for the year. We believe the equity market is still showing a green light due to various fundamental factors. Positive economic growth, relative valuations to bonds, and high forecasted earnings growth all create a positive backdrop for equity performance over the next 12 to18 months. Risks to this outlook are the relatively high valuations from a historical perspective that equities show and the withdraw of Monetary Policy support many speculate could happen soon. Typically, the withdrawal of Monetary Policy will compress the premium investors are willing to pay for equities, and this leads to downside in equity prices when corporate profits are not growing. Today, while the decrease in Monetary Policy could create some headwinds for equities, we believe investors should be positioned at their target weight for equities as expected earnings growth is higher than what we typically see. Within equity allocations, we see a reason to be slightly overweight in International Equities, as valuations look much less stretched across the space than for Domestic Equities. We continue to favor an overweight to high quality companies with long-term earnings growth, and we believe a portion of equity allocations should be to areas doing better when economic growth is strong, and inflation is higher – such as Small Cap Equities and real estate. Overall, we are neutral weight to equities as a whole and have a slight defensive tilt toward high quality and lower beta [2].

Our outlook for bonds continues to be less constructive and we remain underweight in Fixed Income relative to targets. While yields have risen during 2021, they remain at all-time lows across maturities; there is a direct correlation in the total return investors have made across the Fixed Income market over the previous 40 to 50 years and the level of yields. This relationship can be seen in the chart below comparing the 10-Year Yield with the 5-Year Total Return for the Bloomberg Barclays U.S. Aggregate Bond Index over the last 45 years. One area we tend to deviate from conventional thinking amongst investors is that most have positioned bond allocations for rising interest rates. However, we believe rates will continue to fall in the long-term, which is why we have been buyers of the recent rise in interest rates during the year. Our outlook is moderating growth and inflation will begin to create a backdrop for lower rates. Since the United States is one of the only major economies with positive interest rates, drawing investors in could be a major catalyst for lower rates as well. Consequently, while we are underweight in fixed income, we have been lengthening duration in fixed income allocations to take advantage of higher rates in the short-term.

Chart created via Bloomberg, L.P. as of 8/31/2021.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. It is suggested you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Diversification does not protect against loss of principal.

The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. The S&P 500 Index focuses on the large-cap segment of the market; however, since it includes a significant portion of the total value of the market, it also represents the market. The Nasdaq Composite is a stock market index that includes almost all stocks listed on the Nasdaq stock exchange. Along with the Dow Jones Industrial Average and S&P 500, it is one of the three most followed stock market indices in the United States. The Russell 2000 Index® measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The Bloomberg Barclays Intermediate US Government/Credit Bond Index is a broad-based flagship benchmark that measures the non-securitized component of the US Aggregate Index with less than 10 years to maturity. The Composite Index of Leading Indicators, otherwise known as the Leading Economic Index (LEI), is an index published monthly by The Conference Board. It is used to predict the direction of global economic movements in future months. The Index is composed of 10 economic components whose changes tend to precede changes in the overall economy

All indexes are unmanaged and an individual cannot invest directly in an index. Index returns do not include fees or expenses.

[1] Source: https://fulfillment.lordabbett.com/file/16cc35ecc5b8ad2d36de025222fcca40/filename/Volatility_Brochure#:~:text=In%20fact%2C%20in%20any%20given,Index%20historically%20has%20been%2014%25

[2] Beta is a measure of the volatility—or systematic risk—of a security or portfolio compared to the market as a whole.

First Quarter Recap

The first quarter brought political change and increased optimism that reprieve from the global pandemic is within reach. President Biden assumed office with a Democrat-controlled legislature, Congress passed a $1.9 trillion stimulus package, and vaccine distribution accelerated across the country with nearly 100 million Americans receiving at least one dose. New daily Covid cases peaked at the beginning of January before rapidly declining through March, and states continued lifting restrictions allowing businesses to welcome more customers in person.

The Bureau of Labor Statistics reported the U.S. added 916,000 jobs in March, and the unemployment rate declined to 6.0% (down from last April’s rate of 14.8%) with leisure and hospitality posting the largest gains. The Consumer Confidence Index (CCI) from the Conference Board reached its highest level since the beginning of the pandemic. Also, business sentiment, measured by the Institute of Supply Management’s Manufacturing Purchasing Managers Index (PMI), registered its highest reading since 1983. Demand for manufacturing industries was strong as the recovery gained a foothold. But supply and labor constraints caused some pricing pressures; as a result, inflation indicators are likely to rise in the coming months especially as prices are compared to last year’s price levels which were driven lower by the pandemic. Despite all of this positive momentum, the Federal Reserve committed to remaining accommodative to support the recovery by leaving rates low and continuing asset purchases until further progress is made towards full employment.

Cyclical sectors, such as energy and financials, continued their outperformance in the first quarter as the outlook for economically sensitive industries improved. The second round of direct payments will likely help spur consumption as businesses reopen and consumers have extra cash from the stimulus and higher savings rates. Among asset classes, small cap equities and real estate outperformed as investors priced in a robust economic recovery for 2021. Investors trimmed their holdings in large technology companies and other crowded trades as analysts had to assess whether future earnings growth could support all-time high valuations or if earnings had been pulled forward due to Covid trends. Still, U.S. equity valuations remain above their historical averages with the S&P 500 up nearly 6% in the first quarter. These valuations underline the need for portfolio diversification and careful security selection.

Outlook

While we attempt to steer clear of making matter of fact statements about what WILL happen, we believe investors must be aware of the current environment and where it is likely to lead us. This, of course, is how we derive our investment thesis and position portfolios. We remain objective about the range of possibilities, assigning probabilities, and diversifying amongst them to generate the best risk-adjusted return. We believe there are a few possibilities in this current environment that have higher probabilities than others. For one, from a top-down perspective, we believe equities will outperform bonds. Our research tells us we are at the start of a new economic expansion, while the monetary policy framework, adopted during 2020, has brought us to 2021 with historically low interest rates. During the fourth quarter of last year, when the world was on the verge of opening again due to positive vaccine news, we decided to underweight fixed income relative to target-weight in client portfolios. We believed drawing closer to the reopening of the global economy would cause nominal bond yields to move drastically higher.

When yields move up, the price of bonds go down, which then generates a negative return. We continue to hold the view bond investors will receive a lower return than what they have historically experienced, and higher inflationary pressures will generate negative real returns for bond investors. However, we adhere to the idea bonds play a key role in portfolio construction across longer time horizons, and another dramatic move in interest rates could create attractive buying opportunities. While we have remained underweight in fixed income, we do not currently believe in significantly overweighting equities. Our belief is there must be both a top-down reason and bottom-up reason for significantly overweighting an asset or asset class. While the new economic expansion and easy monetary policy provides an optimistic backdrop for global equities, their valuations cause them to be expensive. We like to use the Federal Model to value equities relative to bonds. This measure takes the reciprocal of the Price/Earnings ratio, generating an Earnings Yield, and compares the ratio to the yield investors receive on a risk-free bond – typically the 10-Year Treasury. When the Earnings Yield for stocks is greater than the yield investors are getting on their respective risk-free bond, then stocks are relatively attractive, as is the case today. In the chart below, we can see the Earnings Yield for the S&P 500 minus the 10-Year Treasury Yield. While the spread between the two is currently positive, signaling attractive valuation for stocks relative to bonds, the measure is below its 20-year average line.

While stocks are relatively attractive to bonds, they are expensive on an absolute basis when we look at other measures such as the Price/Earnings ratio, or the Cyclically Adjusted Price to Earnings (CAPE) ratio. We have also attempted to diversify some of this risk by investing more heavily in international stocks, and emerging market stocks. These stocks have valuations which are less extreme and have tailwinds if we see higher inflationary pressures. If we are underweight in fixed income, but not overweight in equities, then where do we believe investors should invest the rest of their capital? We have looked to alternative assets, typically having much lower correlations to the broad equity market, to look for both opportunities and diversification benefits. Even within the equity allocation in client portfolios, we have a targeted allocation to real estate which has historically displayed lower correlation to the rest of the equity market and a higher correlation to economic growth. Other areas of the market we consider alternatives are commodities and hedged equity. These alternatives are exposures in portfolios we find provide greater downside protection in periods of heightened volatility. We believe volatility will be a key player over the next few years since we have seen political uncertainty rise across the globe and financial assets are priced richly. To us, coupled with a positive macroeconomic backdrop, this volatility will generate substantial buying opportunities as did the Covid pandemic generated within financial markets in 2020.

To learn more about how Acumen can help you Invest Intentionally®, please contact us.

Information and charts used in this commentary was obtained via Bloomberg L.P.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Diversification does not protect against loss of principal.

The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. The S&P 500 Index focuses on the large-cap segment of the market; however, since it includes a significant portion of the total value of the market, it also represents the market. The Russell 2000 Index® measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The Bloomberg Barclays Global High Yield Index is a multi-currency flagship measure of the global high yield debt market. The index represents the union of the US High Yield, the Pan-European High Yield, and Emerging Markets (EM) Hard Currency High Yield Indices. The Bloomberg Barclays Aggregate Bond Index is an index used by bond traders, mutual funds, and ETFs as a benchmark to measure their relative performance. The index is broadly considered to be the best total market bond index, as it is used by more than 90% of investors in the United States. The FTSE Nareit All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs. Constituents of the index include all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property.

The Purchasing Managers Index (PMI) is a measure of the prevailing direction of economic trends in manufacturing. The PMI is based on a monthly survey of supply chain managers across 19 industries, covering both upstream and downstream activity. Price to forward earnings is a measure of the price-to-earnings ratio (P/E) using forecasted earnings. The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. The CCI is based on the premise that if consumers are optimistic, they will spend more and stimulate the economy but if they are pessimistic then their spending patterns could lead to a recession. The CAPE ratio is a valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle.

Schedule a Meeting

Our mission is to help you and your family Invest Intentionally®.
Contact us today to start your journey.

Start your journey

When considering real estate as an investment, there are two predominant questions to consider. What is the best TYPE of real estate to own and is NOW a good time to invest? We believe single-family residential rentals represent a growth opportunity for now and the future. According to a Gallup Poll, real estate remains one of the most favored investment to Americans and has ranked in the top spot every year since 2013.^[1] However, it can be a barrier for most investors because it can be considerable work. We believe residential single-family housing is an ideal real estate investment and an important method to diversify an asset portfolio.

Inventory at All-time Lows – The availability of single-family “for-sale” homes has dwindled as the Coronavirus pandemic fueled demand for single-family homes. The average 2020 for-sale inventory is 63% of the 1982 level.^[2] According to the World Bank, the United States population in 1982 was around 231 million compared to 2019 with a population of 328 million. With almost an additional 100 million people in America, the for-sale inventory is considerably less than nearly 40 years ago. Dr. Frank Nothaft, Chief Economist for CoreLogic says, “The demographic tailwind has arrived as Generation X and Millennials drive housing demand. Lower-priced home values increased about one and a half times faster than higher-priced home values in November, as first-time buyers tend to seek out homes within the lower price ranges.”² Housing demand should continue to be fueled by a large generational move into prime home buying age and low mortgage rates. We anticipate continued supply constraints as both building materials and labor experience Coronavirus-related tension. Builders worked to provide new housing starts, particularly the latter half of 2020, but volatile material prices (extremely high lumber prices in August) and lack of available land kept homebuilders from meeting much of the demand. Additionally, based on the National Home Builders Association, home construction has yet to return to levels seen prior to the 2008 Great Recession.[3]

Income is Scarcer than Ever – Bonds have long been a favored investment because they paid income and mitigated risk over equities. The United States 10-year Treasury currently sits around 1.5% and remains at historic lows. Compare this rate to 15% in 1981 when the baby boomers were in accumulation phase. Fixed income does not offer the preservation of capital it once did. We believe residential real estate meets a long-term need and the single-family “type” of real estate meets a changing-need list to provide consistent rental income. Could single-family real estate be the new proxy for bonds?

Residential Real Estate Meets a Need – People will always need a place to live. Residential real estate benefits from a large pool of potential tenants compared to commercial which relies on businesses. As businesses and consumers acclimate to virtual marketplaces and remote work opportunities, we believe the demand for single-family homes will increase. The pandemic has created a change in housing needs. The time spent at home has placed an emphasis on additional space – indoors and out. Remote work has unlocked new home considerations outside of typical criteria such as commute ranges or city specific cost-of-living. One of the most searched Zillow words of 2020 was “pool” and a dedicated home office space remains at the top of surveys.[4] A Zillow survey shows 31% of respondents wish to live in a home with a dedicated office space, 30% desire to live in a larger home, 29% to live in a home with more rooms, and 25% to live in a less-dense area with fewer neighbors.^[5] In a Freddie Mac survey, respondents listed the top factors influencing single-family housing as their preferred rental choice. The top three factors were laundry, privacy, and parking.^[6] These factors make a compelling case for why single-family home demand will continue and shift away from large multi-housing buildings.

Value – Multifamily housing has long been a hot sector for large hedge funds as they can acquire 100+ units in a single transaction. While multifamily housing has performed well, there might be an abundance of capital chasing a small pool of opportunities and creating a “priced-to-perfection” scenario. Conversely, by purchasing a single-family residence, the buyer can capitalize on the undervalued anomalies in the market as a “one off” transaction. The rise in remote work has sparked a suburban boom creating buying opportunity further away from the urban core. What was previously considered too far of a commute is now on the search radar. According to Corelogic, the United States single-family rents increased 2.9% year over year, which is more than double the rate of inflation over the same time period.^[7] There is immense demand for single-family rentals with general occupancy rates at just over 95%, indicating the highest rate since 1994.^[8] Some industry experts believe the single-family rental home sector will outpace multifamily housing in terms of rent and revenue. Additionally, institutional owners are estimated to own less than 2% of the total SFR housing stock.^[9]

Location, Location, Location – The best real estate opportunities may exist in smaller markets as affordability becomes more of a driver. Many workers no longer report to the office, so there is increased mobility in the workforce. Business-friendly states with low taxes will likely continue to experience growth. Increasingly, densely populated cities and states are becoming “move out” markets. For the seventh straight year, more people left California than moved in. In a recent UC Berkeley poll, 52% of registered voters say they have considered leaving the state.^[10] The top reasons are high cost of housing, high taxes, and political culture. A recent United Van Lines migration study listed metros with the highest move out/move in for 2020. New York, New Jersey, and Illinois were the top three spots on the outbound list in 2020. Tennessee was seventh on the inbound states with South Carolina, North Carolina, Alabama, and Florida also making the list. Understandably, Tennessee presents a continued opportunity to invest in residential real estate because of the increased desire to live in our great state.^[11]

It is our opinion there will be continued demand for single-family homes, particularly in a strong market like Tennessee. Opportunity exists to capitalize on price and location in a time when Tennessee cities are projected to attract more business and generate employment opportunities. While the future is bright for Tennessee real estate, there are also numerous barriers to entry. Unlike other investments, real estate is not a passive investment. From tenant relations to rent collection to maintenance requests, real estate can be very time consuming. Procuring the right real estate investment requires knowledge and contacts in individual markets, particularly in high growth markets. These investments also require a strong overview of industry knowledge relative to local zoning and ordinances, boundary and surveys, covenants, restrictions, HOAs, and property maintenance. Many good opportunities require some cosmetic updates and remodeling and can also require improvements after tenants vacate. The many factors and complexities to successful real estate investing serve to eliminate many would be investors from entering. Conversely, having the knowledge and resources needed to navigate those same complexities and barriers can set the stage for a great investment with the potential to generate great returns and appreciation.

To learn more about how Acumen can help you Invest Intentionally®, please contact us.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however, no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results.

[1] “Stock Investments Lose Some Luster After Covid-19 Sell Off”, Gallup, April 2020

[2] “US Home Price Insights: Through Nov 2020 with Forecasts from Dec 2020 and November 2021”, Corelogic, Jan 2020

[3] A Decade of Home Building: The Long Recovery of the 2010s | Eye On Housing

[4] From ‘Zoom Rooms’ to Chef Kitchens: Zillow’s Top 10 Home Trends for 2021 – Dec 10, 2020 (mediaroom.com)

[5] “More Remote Work Opportunities May Make Suburbs More Desirable”, Zillow Research, May 13, 2020

[6] “Single Family Rental: An Evolving Market”, Freddie Mac Multifamily, October 2018

[7] “Single-Family Rents Increasing Twice As Fast As Inflation”, Corelogic, March 2020

[8] “Q3 02 Single -Family Rental Investment Trends Report”, Arbor Research, Q3 2020

[9] “Where Is The New Class Of Investors Buying Single-Family Rentals?”, Forbes, Nov 2019

[10] “For 7^th Year in A Row, More People Left CA than Moved In”, nbcbayarea.com, Nov 2019

[11] “United Van Lines’ National Migration Study Reveals Where and Why Americans Moved in 2020”, Unitedvanlines.com, January 2021

I. What is a SPAC?

A Special Purpose Acquisition Company (SPAC) is a shell company with no actual commercial operations created solely to raise capital through an initial public offering to acquire a private company. Sponsors are required to acquire a company within a two-year span (additional year may be added given permission by SEC/investors). Following the acquisition of the targeted company, the SPAC symbol is retired, replaced by the now public company on the stock market.

SPACs are formed by a sponsor or experienced management team who possess expertise in a certain industry or business sector with intention to pursue deals in a selected area. However, typically the sponsors are NOT obligated to a specific field unless stated in the disclosure. The management team or sponsor has nominal invested capital translating into ~15% to 20% interest in a SPAC. The remaining 80% to 85% is open to public shareholders through units, or common stock, and a fraction of a warrant.[1]

[1] A warrant is a contract that gives the holder the right to purchase from the company a certain number of additional shares of common stock in the future at a certain price, often a premium to the current stock price at the time the warrant is issued.

II. SPAC versus Traditional Initial Public Offering (IPO) – Simplified

The traditional IPO process requires immense efforts to implement. The company begins by finding the most suitable underwriter for the IPO which involves many meetings. Next, executives travel to potential investors to assess demand and other factors for their IPO. As previously stated, this is a tiring process for executives, in addition to still having daily responsibilities for their company.

Through a SPAC, the sponsor(s) approaches the company, and does most of the work for them resulting in less work for the private company.

III. Initial Business Combination

The initial business combination is an important phase for an investor as the SPAC changes from essentially a “trust fund” to a functioning company. If it is disclosed the SPAC is required to acquire shareholder approval, it will provide a proxy statement. Shareholders of the SPAC can vote on approval or redeem their shares. If a shareholder decides to redeem their shares, it is the pro rata amount of funds in the escrow. For example, if the IPO is ~$10, and the shareholder bought 100 shares at $20, the share of the trust account is $1,000, not $2,000.

IV. Current Environment

According to SPAC Alpha, the number of SPAC IPOs priced and mergers closed increased ~320% from 2019 to 2020 [Appendix, 1]. The value of SPAC IPOs drastically increased ~512% to $83.4 Billion [Appendix, 1]. Market share by number of US-listed SPACs versus all US IPOs averaged 18.4% from 2015 to 2019 with the highest market share of 23% (2019) [Appendix, 2]. However, in 2020 the market share spiked to 53% [Appendix, 2].

In 2020, the equity returns on SPAC mergers, NASDAQ, and S&P 500 were 41%, 38%, and 13%, respectively[Appendix, 3].

V. Information to Consider

A 2018 study by Goldman Sachs focusing on 56 SPACs that completed acquisitions or mergers found they tend to underperform the S&P 500 during the 3-, 6-, and 12-month period AFTER transaction. A 2017 through mid-2019 study of 108 SPACS in the United States found SPACs had an average of 2% return. However, factors, such as COVID and the “rise of the retail investor”, seem to have affected the financial markets making room for abnormal SPAC returns.

Shareholders must be careful in fully analyzing SPAC disclosures as additional funding is typically needed and the interests of the sponsors might pivot from the interests of the shareholders. Shareholders should:

Be aware of dilution of shareholder’s interest.
Must pay attention to prospectus and reports.

Attention must be paid toward the investor base. A possible indicator of higher quality is the combination of who are the sponsors and larger investors. With most things, higher quality managers tend to enter first, and after their deals have been made, lesser quality managers are attracted (SPAC boom).

VI. Conclusion

SPACs offer many advantages including higher valuation, control, and time. If one were to rely on historical analysis, public companies tend to have higher valuation multiples than private. With traditional IPOs, most owners are unable to maintain a significant percentage of their companies. However, the SPAC structure allows owners to maintain a significant percentage. Speed is usually an obstacle for owners considering entrance to the stock market. The nature of traditional IPOs limits their ability to predict when the process will be complete. However, SPACs are required to acquire a company within a two- to three-year span, giving owners clarity on timelines.

One might question, why now? Well, it seems SPACs are being considered a mainstream alternative as well-known investors such as Richard Branson, Tilman Fertita, and Chamath Palihapitaiya have entered the field. Sponsors and owners might observe the increase in retail investor activities as a positive, so they want to capitalize on the increase of cash flow. Finally, in a year marked by volatility, quick entrance to the stock market at a fixed price can be seen as an advantage.

Yes, it may be appealing to enter the SPAC field as it has recently shown a strong return on investment. However, due to the nature of the asset vehicle itself, it is entirely speculative. The investor must place his full trust in the sponsors’ ability to acquire a robust company. Also, before one was to invest, she/he must read the disclosure intensely as sponsors’ and investors’ interests can separate at certain occasions in the acquisition of the target company.

With the recent SPAC performance of nearly 41%, it is worthy to remember here, an average SPAC returned a measly 2% from 2017 to 2019. However, we must remember, these are not ordinary times. The world is under conditions rarely observed before. A pandemic-stricken world has reduced the normalcy of the economy and everyday life while adding more volatility to financial markets.

In our opinion, the surge of stimulus and the rise of the retail investors are most likely the culprits behind the continual demand for highly speculative assets, such as Bitcoin and SPACs. Instead of looking at historical data or educating themselves on a topic, the average investor is flocking to the “hot news,” in this case, SPACs. We believe SPACs will perform well short term, but, contrary to current popular belief, there will be losers in the SPAC market, and one must choose wisely if they wish to enter the SPAC scene.

VII. Additional Sources/Notes

What You Need to Know about SPACs

https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin

Special Purpose Acquisition Companies

https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies

Conflicts of Interest

https://www.natlawreview.com/article/spac-disclosures-sec-focuses-conflicts-interests

Spectacular Rise of SPACs

https://www.npr.org/2020/12/29/949257672/the-spectacular-rise-of-spacs-the-backwards-ipo-thats-taking-over-wall-street

VIII. Appendix

[1] SPAC Alpha

[2] SPAC Alpha

[3] Statista

To learn more about how Acumen can help you Invest Intentionally®, please contact us.

Charts used in this commentary was obtained via Bloomberg L.P.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Diversification does not protect against loss of principal.

The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. All indexes are unmanaged and an individual cannot invest directly in an index. Index returns do not include fees or expenses.

For years, GameStop has struggled to adapt to the changing landscape of video gaming. It was founded in 1996 when the Nintendo 64 and first-ever PlayStation were exploding in popularity. Online retail was just getting started. Amazon and eBay had just launched their E-commerce sites the year prior when GameStop began offering gamers a place to buy, sell, and trade new and used consoles, and videogames. But, as the internet progressed, GameStop stuck to its brick-and-mortar strategy and failed to establish its online presence. Now, gamers can preorder consoles online and have them delivered to their door. And when they want to sell a used game, they can sell it themselves online.

This situation had led many Wall Street hedge fund managers to short sell (bet against) the company. Simply put, a short seller borrows shares from someone who owns them, sells them on the open market, and agrees to repurchase them to return to the owner later. The short seller hopes the price declines so, when he/she buys back the stock from the market, it will be at a lower price than what they initially sold it. If the short seller repurchases it at a lower price, he/she pockets the difference between their sell and buy prices after returning the shares. If the price increases, the short seller must repurchase at a higher price and lose money.

The chart above shows GameStop’s short ratio in blue which compares the number of shares that have been sold short and the average daily trading volume. The orange line shows the percentage of shares that have been sold short versus all the shares available to be traded. Over time, the bets against GameStop got bigger, and some thought the bets were too big.

Enter Ryan Cohen, the co-founder of the online pet supplies store, Chewy. Cohen’s venture capital firm acquired a 10% stake in GameStop in 2020, and he joined the company’s board of directors in January with hopes he could help transform the brand into a modern online retailer. This acquisition was big news to retail investors who believed in Cohen and his vision for the company. They began sharing their thoughts about a potential turnaround on social platforms, specifically on the Reddit group, WallStreetBets, which now has over eight million members.

But, instead of investing in a turnaround, WallStreetBets began planning something else; members had noticed the massive short-selling of GameStop stock and thought they could coordinate an attack on the hedge funds by forcing a short squeeze. In other words, if the smaller retail investors could band together and purchase GameStop shares, share prices would rise, and the hedge funds, who had shorted the company would be forced to buy their borrowed shares back at a higher price. As the larger hedge funds began buying back shares to close their short positions and limit their losses, the influx of demand sent GameStop shares soaring from $20 to nearly $350 in just two weeks. At the same time, more and more retail investors joined brokerage apps, like Robinhood, to help the cause and to cash in at the expense of the hedge funds. WallStreetBets and internet traders began to target other companies hedge funds had bet against, and companies, such as AMC Entertainment, BlackBerry, and Nokia, were the next on the list. Those companies would see their trading volumes more than double in the last week of January.

Sure, the hedge funds were the first to lose money, and they lost plenty. In just a matter of days, firms lost billions of dollars in the GameStop trading frenzy. But, over time, more retail investors were drawn in by $0 trading fees on easy-to-use brokerage apps and the opportunity to realize huge gains in just a few days. As hedge funds were closing their positions, retail investors kept piling money into GameStop shares either in protest against the Wall Street elite or to gamble the old-fashioned videogame retailer’s shares would keep climbing forever. Ironically, some hedge funds have made millions with new short positions since they knew price correction was inevitable, all at the expense of individual investors.

Demand for GameStop shares was detached from company fundamentals and quickly progressed to market mania. Charles Kindleberger describes how these situations play out in his book “Manias, Panics, and Crashes.” Typical of manias, some event changes the outlook, investors chase after some investment opportunities to the point of excess, and then once the excess is realized, investors rush to spare their returns and reverse the expansion. This panic causes investors to switch from real or financial assets (like GameStop stock) to cash and liquid assets resulting in the crash of the related asset prices. As of this writing, GameStop shares are trading at around $40, an 88% decline from the high reached at the end of January.

The trading frenzy is scarily similar to the outlawed “bucket shops” of the late 1800s when customers wagered on stock price movements. But, like the low-cost ETFs and free brokerage apps of today, bucket shops also opened financial markets to a new wave of participants. Robinhood and others have removed the barriers for smaller investors by eliminating account minimums and trading fees. The rise of retail investing and its effect on the broader market is a phenomenon some have dubbed the “Robinhood Effect,” and its full implications may take time to understand. While the events of recent weeks have been a case study on the matter, they have only affected a select few companies and have left everything else unaffected. Volatility indicators of major equity indices have remained near their historical levels so far this year. Investors with a well-diversified portfolio, backed by a thorough research process, can significantly reduce their risk to periods of mania and panic. We believe awareness of these excesses allows us to conduct better research and make better decisions for our clients. The bottom line is you can in all likelihood ignore the GameStop news if you keep a long-term investment horizon and focus on fundamentals.

To learn more about how Acumen can help you Invest Intentionally®, please contact us.

Notes

Two Small-Time Investors Were Buying GameStop Stock Before It Was Cool
- https://www.wsj.com/articles/two-small-time-investors-were-buying-gamestop-stock-before-it-was-cool-11612261801https://www.wsj.com/articles/two-small-time-investors-were-buying-gamestop-stock-before-it-was-cool-11612261801
The Real Force Driving the GameStop Revolutionhttps://www.wsj.com/articles/the-real-force-driving-the-gamestop-amc-blackberry-revolution-11611965586
“Where the Common People Could Speculate”: The Ticker, Bucket Shops, and the Origins of Popular Participation in Financial Markets, 1880–1920 https://doi-org.proxy.lib.utc.edu/10.2307/4486233
“Manias, Panics, and Crashes: A History of Financial Crises” Robert Z. Aliber; Charles P. Kindleberger

Chart information used in this commentary was obtained via Bloomberg L.P. as of 12/31/2020.

2020 Recap

We recently read a quote stating, “2020 is like looking both ways before crossing the street and then getting hit by an airplane.” No matter how cautious we were, it seems we could not escape the impact of the most challenging year in our recent history. It was a year to be remembered, first as a health care crisis, and then for the first ever complete halting of global economic activity brought on purposefully by governments due to the pandemic. It should also be remembered as a tale of two recoveries. The first recovery was slow and sluggish and still has not recovered to its previous level which is the recovery of global economic activity. While the incongruously high levels of jobless claims and absurdly low levels of consumer spending have trended back in the right direction, the recent rate of change has stagnated while waiting for the pandemic to come to its end. The second recovery can be seen in prices of riskier assets, which caught most investors by surprise given the economic circumstances. It was swift and, if you blinked, you could have missed it. We saw the second largest quarterly drawdown over the last 20 years in the S&P 500 (which was essentially matched across various other equity indices), followed by the largest quarterly increase, and the two subsequent quarters which were well above the quarterly average return of 1.64%. As shown below, during this recovery, we also saw the spreads of High-Yield (junk) Bonds over Treasuries compress to levels far below their average, and other speculative assets, such as SPACs and Bitcoin, produced parabolic returns. The contrast of performance of these assets in the first quarter of 2020, relative to which was seen in the following three, was not only unique in its speed, but also in the fundamentals driving the rally.

During February and March, investors divested riskier assets, such as equities and lower-rated corporate credit, and flocked to cash and treasuries. The U.S. Dollar Index (DXY) appreciated more than 8% in just ten days – a move incredibly atypical for currency markets. Almost every other financial asset suffered wide losses as liquidity completely evaporated. Even investment-grade corporate bonds with the lowest default rates could not be offloaded fast enough. This selloff happened as investors began digesting a complete stop in economic activity. Just a month later, the dynamics of the global economy became much easier for investors to understand. First, the continuous news flow on progress made in understanding and treating the virus gave investors optimism. The second dynamic was just how likely the sharp change in asset prices was in such a short amount of time. The CBOE Volatility Index (VIX) completely blew through previous highs and asset valuations were incredibly attractive, giving many investors comfort in weathering the coming future storm through the second half of the year with the pandemic. Lastly, and the one which we believe is the most important to understand what happened in 2020 and what we are most closely watching in 2021, fiscal and monetary policies provided both protection and liquidity to financial markets and consumers. In the matter of four months (2/26/2020 – 6/10/2020), the U.S. Federal Reserve increased its balance sheet by more than $3 trillion. Stepping way outside of their typical mandate, they began buying up financial assets (even corporate bonds) and propping up financial markets with massive amounts of liquidity. Even a global pandemic, which had not matured to its fullest threat, could not keep investors on the sidelines with the level of support from central banks. This action was not limited to just the United States since central banks across the globe joined in. In the United States, fiscal policymakers stepped in by providing financial support to struggling businesses, the unemployed, and even the employed with direct payments to boost consumer spending.

The fourth quarter was a different story. Once again, cases were on the rise across the globe and new lockdowns were following. In the United States, we faced one of the most volatile election seasons imaginable, and many were curious if we would even know the true result of the election until months after election day. Election day passed and markets reacted positively to both the initial results which showed the potential for gridlock in Washington and to positive vaccine news. While October presented a negative return for most risk assets, November and December carried a 16.7% rally in the S&P 500. This rally also breathed life into sectors and assets which had lagged by miles through the first ten months of the year. Sectors, such as financials and energy, commodity markets, and other cyclically sensitive assets, regained some relative strength against what had shown momentum previously. Sudden vaccine optimism, accommodative monetary and fiscal policy, an even more fiscally accommodative administration now up to bat, and the lack of opportunities to find yield, lit a massive spark across financial markets for a new “reflation trade”. This reflationary thesis is the thought 2021 will bring a resumption to normalcy, even more liquidity, and higher global growth than we experienced even before the pandemic.

2021 Outlook

In an attempt to shy away from prognosticating the absolute direction of financial markets, which we believe is ultimately impossible, we want to provide possible trends or possibilities for financial markets in 2021. These are the factors we are keeping a keen eye, and the ideas we think could have the largest effect on financial assets over the medium and long term. We prefer to keep clients well-diversified and exposed to the market because we believe it is quite difficult to predict with 100% accuracy and even harder to time. However, we make tactical allocations and tilts based on the opportunities, risks, and trends we see and our understanding of their probabilities. We are watching the following:

Fiscal and Monetary Policy should continue to be ultimately well-accommodative in 2021. The Federal Reserve has given no inkling of deciding to slow down its asset purchasing program. They are currently purchasing over $100 billion in assets every month to provide liquidity to financial markets and, if they keep this purchase up for 2021, we will see more than another $1 trillion added to the balance sheet. From a fiscal perspective, the new administration will likely usher in more stimulus and aid to the consumer and businesses, and we could be well on our way to fully experiencing Modern Monetary Theory in action. In the short to medium term, we believe this is ultimately bullish for riskier financial assets like equities. In the long term, we could see some adverse effects of a massive debt overhang.
Vaccines will likely be the star of the show in 2021. Three vaccines have been approved for full use, with two currently being widely distributed across the United States. Current market prices have assumed there will be widespread voluntary inoculation with no adverse effects.
Valuations going into 2021 are higher than what we have historically seen, mostly across all asset types. These valuations, specifically in the equity market, need to be supported by earnings growth across the global economy. The current premium investors are paying for more economically sensitive assets can probably be supported by current interest rates and liquidity, but an expansion in the premium is unlikely, and earnings will have to catch up.
Inflation is probably one of the biggest trends to pay attention to in 2021. In fact, the weaker U.S. dollar, overweight cyclical sector, and global economic growth reflation investment thesis might be the most crowded. This weakening of the dollar does not mean it is wrong. We believe the deficit and previous overvaluation of the U.S. dollar could continue the current trend, but the large inflationary pressures are simply impossible to find without an increase in the velocity of money. This pressure means people need to spend the dollars injected into the economy.
We are paying particular attention to the trends in 2021 of the continued dominance of the technology sector and the new developments across technology and healthcare. While we do not prefer to largely overweight the crowded trade of Large Cap technologies, we believe an overweight to the technology and healthcare sectors is the correct positioning for the long term. We have continued to focus on the disruption beginning before the pandemic which has likely been exacerbated by the experiences in 2020. Genomics across the healthcare sector is one of these areas we believe gives investors access to exponential growth opportunities and diversification from the broad equity market.

To learn more about how Acumen can help you Invest Intentionally®, please contact us.

Information used in this commentary was obtained via Bloomberg L.P.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Diversification does not protect against loss of principal.

All indexes are unmanaged and an individual cannot invest directly in an index. Index returns do not include fees or expenses.

Definitions

As 2020 comes to an end, we look forward to what 2021 will bring. We hope more happiness, less uncertainty, stronger relationships, and more time together will take place. With only a few weeks left in 2020, we would like to remind you there are some steps you can take to make the most of this year financially.

Gifting to Family Members

Annual gifts including gifts to 529 plans – the maximum an individual can gift in 2020 without reducing their lifetime exemption amount ($11.58 million) is $15,000. This amount is also known as the annual gift tax exclusion amount. Additionally, a special lump-sum contribution rule exists for 529 plans where an individual can gift five years’ worth of the annual gift tax exclusion ($75,000 in 2020) in one year to a 529 and elect to spread the amount out over five years.
- Hypothetical Case 1 – Mr. and Mrs. Smith want to gift to their son and daughter-in-law. Mr. Smith can gift $15,000 to his son and $15,000 to his daughter-in-law. Mrs. Smith can gift $15,000 to her son and $15,000 to her daughter-in-law. The total amount of non-taxable gifts is $60,000.
- Hypothetical Case 2 – Mr. and Mrs. Smith want to fund a 529 for their granddaughter who will be attending college in five years. They want to gift the largest amount so it can grow tax-free for college expenses in a relatively short amount of time. Mr. or Mrs. Smith can contribute $75,000 individually or $150,000 combined and elect to spread this amount over five years. They will not be able to gift $15,000 to their granddaughter (in cash or through 529 contributions) until after five years.
Roth accounts for young professional children – One of the most tax efficient type of retirement accounts is a Roth IRA in which after-tax dollars can grow tax-free. Many young individuals who are working part-time or full-time jobs do not contribute to a Roth IRA even though they can contribute up to $6,000 or the amount of their earned income for the year. Additionally, individuals who are under a certain income threshold can both contribute to their 401k as well as make Roth IRA contributions.
- Hypothetical Case 1 – Mr. and Mrs. Lee’s son is home for the summer from college and has taken up a part-time job. He earned $5,200 in wages for the summer so he or his parents can contribute to a Roth IRA in his name for that amount.

Gifting to Charity

$300 above the line deduction – An above-the-line deduction is a deduction that can be taken in addition to the standard or itemized deduction amount; however, the deduction cannot be counted twice. The CARES Act allows for an individual or married couple filing a joint return to take an above-the-line deduction for up to $300 in donations to a 501(c)(3) organization.
- Hypothetical Case 1 – In 2020, Mr. and Mrs. Brown donate $300 in cash to a qualified 501c3 organization so do not have to pay federal taxes on this amount.
Donations of Cash or Appreciated Assets to Donor Advised Funds – Charitably inclined individuals with donor-advised funds can deduct up to 60% of their Adjusted Gross Income (AGI) for cash contributions to their fund and 30% of their AGI for contributions of appreciated assets.
- Hypothetical Case 1 – Mr. and Mrs. Patel have 500 shares of XYZ stock which has a current value of $100,000 and $70,000 worth of unrealized, long-term capital gains. They donate $25,000 every year. They decide to front load fund their donor-advised fund with the 500 shares of XYZ. They do not have to pay taxes on the gain and also take a deduction up to 30% of their 2020 AGI.

Tax

Retirement Conversions – The CARES Act has waived Required Minimum Distributions (RMDs) from retirement accounts for 2020. This waiver provides a rare opportunity for individuals to replace the income recognized through RMDs with a Roth conversion. Roth conversions are not only advantageous for those in RMD mode; individuals who have capacity to recognize income at a low tax rate can convert an amount up to the tax bracket limit and enjoy tax-free growth.
- Hypothetical Case 1 – Mr. and Mrs. Garcia usually have a combined annual RMD amount of $45,000 and are in the 12% tax bracket. Since they do not have to take their RMD for 2020, they decide to convert $45,000 to a Roth IRA and pay taxes at the 12% tax rate so they can lower their RMD amount for subsequent years, pay taxes at a historically low tax rate, and create a tax-free account for legacy planning.

Hypothetical Case 2 – Mrs. Williams is a 28-year-old who was just notified of a large raise which will take effect in 2021. She and her husband are currently in the 12% tax bracket but the raise will propel them into the 22% bracket. Mrs. Williams has $15,000 in a traditional 401k and her plan allows for in-plan Roth conversions. Mrs. Williams converts the $15,000 to Roth funds and pays taxes at 12% on the conversion. When she retires at 62 years old, her Roth amount, averaging a 5% annual growth rate, has grown to a tax-free amount of $78,800.22.

These are just a few examples when it comes to planning strategies. The planning team at Acumen is here to help if you have any questions. Please remember that due to increased processing times, we need to execute any strategies well before year end to ensure they are processed in time. Smart financial decisions year after year help increase the probability of financial success. As Warren Buffett says, “The more you learn, the more you earn.”

Thank you for working with us and stay safe!

To learn more about how Acumen can help you Invest Intentionally®, please contact us.

Sources:

2018 Charitable Giving Statistics, Trends & Data: The Ultimate List of Charity Giving Stats | Nonprofits Source

Giving USA 2020: Charitable giving showed solid growth, climbing to $449.64 billion in 2019, one of the highest years for giving on record

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice. Any opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however, no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions.

With the presidential election only one week away, our team at Acumen has been researching a variety of topics relating to the potential impacts of the election and we are sharing this information with you in a three-part series called “The Election Effect.” In today’s final installment, we explore the policy implications on investment portfolios. We hope you find this information interesting and welcome your thoughts on the series.

The Election Effect: Part 3 of 3

Policy Implications on Investment Portfolios

Acumen has previously communicated our belief the broad understanding of the effect of presidential elections on financial markets is widely misinterpreted. From our research, we found the party holding control of the White House, or even sometimes the White House and Congress, does not have a high correlation with asset class returns in financial markets. This research does not discount the potential definitive effect this election could have on specific asset classes or industries. In fact, we believe we can better position portfolios for the future after assessing many of the potential policy moves by both candidates and after assessing the odds of each outcome.

One of the possible misunderstandings investors may have about this election season is the fear of sudden financial market turmoil if Joe Biden is elected president. Whether our research about political party correlation to financial market returns reigns true or not, we must be aware of the more progressive ideas a Biden presidency could bring. One factor we have focused on extensively is the sudden increase in the betting average Biden will become president over his polling average and the decrease in the betting average Trump will become president below his polling average. We saw this trend play out in 2016 with Trump and Hillary Clinton. Clinton’s polling average showed her in a significant lead over Trump, but their betting averages were much closer together. We saw the two measures begin a greater divergence after the first debate. Since then, the S&P 500 is up more than 6%, the 30-year yield is up 11 basis points, and the spread in high-yield bonds versus treasuries is down more than 10.5 basis points. These indicators are all financial market characteristics supporting the forecast that a Biden nomination will not crash financial markets. Granted, there will be long-term implications of a Biden presidency possibly producing slower nominal growth. The implications of a higher corporate tax rate, large fiscal spending, and more heavily regulated markets could be a reason to forecast slower (still positive) economic growth in the long-term. At the same time, industries within the stock market that will probably benefit more from a Biden presidency have outperformed the broad equity market. Sectors such as Industrials and Financials have been outperforming Technology – a sector which will likely face greater scrutiny under a Biden presidency. Those who believe in the forward-looking nature of the stock market are likely discounting a Biden win right now.

We believe understanding policy propositions from both parties and the effects they could have on financial markets is incredibly important. For starters, there are a few policy implications we believe will be realized no matter who is elected. In our eyes, the most important factor to watch would be the pace at which we continue to grow our fiscal deficit. For instance, both candidates are likely to impose a new infrastructure plan. Trump attempted to put an emphasis on the infrastructure during his first term. Biden has said he would propose a $2 trillion spending plan on infrastructure. Obviously, this action should generate better returns in infrastructure assets.

Both candidates also support another stimulus package for the coronavirus pandemic. This influx of liquidity leads us to believe that with the roughly 20% fiscal deficit the IMF has projected for 2020 will continue to grow. Our economy may not grow at the same rate, but we do not believe either candidate will be able to simply reverse the trend. There are major implications to this. For one, a higher than expected increase in economic growth could spark higher inflationary pressures. We believe alternative assets, like gold and real estate, should benefit from these pressures. At the same time, fixed income has become less attractive than both equities and alternatives due to the negative REAL rate of return investors will see across the bond market. This rate is truly one of the only ways governments know how to deal with large deficits – they “inflate it away”. In fact, we have already seen the Federal Reserve change the way they measure inflation targeting. During their last meeting, the Fed said they would now allow inflation to overshoot their typical 2% target after periods of extremely low inflation. This change likely speaks to the prospect of ever actually seeing inflation greater than 2%. Either way, we believe the rate of change towards greater deficits will continue. The other implication that may result from larger fiscal deficits is higher taxes. The Biden administration has offered insight into their plan to cut back much of the Trump administration’s tax cuts and jobs act. These cuts would likely increase the tax rate many “big-tech” companies are currently paying. One way we have begun diversifying this risk is by reaching out into tech disruptors, such as cloud computing and software-as-a-service companies, instead of the crowded trade seen in many large-cap technology stocks. We still believe a strategic allocation into these investments are prudent, but also do not believe it should be the primary source of allocation.

One of the largest policy implications on the horizon is the movement toward a greener future. While a Biden administration and a Trump administration will likely mean much different strategies in the short term regarding our dependence on fossil fuels, this difference is a policy area we believe we will make significant headwinds on in the near future no matter who controls the White House. Green and sustainable energy has become a much greater bipartisan issue over the last few years. We see this issue, as well as a lower dependence on oil and gas, continuing to cause disruption in the energy sector.

To learn more about how Acumen can help you Invest Intentionally®, please contact us.

Information used in this commentary was obtained via Bloomberg L.P as of 10/12/2020.

The opinions expressed in this commentary should not be considered as fact. All opinions expressed are as of the published date and are subject to change. Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. Investments in securities involves risk, will fluctuate in price, and may result in losses. The information has been obtained from sources we believe to be reliable; however no guarantee is made or implied with respect to its accuracy, timeliness, or completeness. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. Diversification does not protect against loss of principal.