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Donna Cournoyer

Donna Cournoyer
In Economy

Take It to the (Debt) Limit

The debt clock is ticking louder.

The nonpartisan Congressional Budget Office recently revised its projections for federal revenues and expenses.

According to the CBO there is now “significantly greater risk that the Treasury will run out of funds in early June”.

Treasury Secretary Janet Yellen said on May 1 that the US government could become unable to pay its bills as soon as June 1 if Congress doesn’t raise the debt limit soon.

These new estimates set a shorter timeline than many experts previously had been forecasting.

House Republicans approved legislation last week that would raise the borrowing limit for about a year, but parts of the legislation are unpalatable to Democrats.

In other comments she’s made recently, Treasury Secretary Yellen is not mincing words: “A default on our debt would produce an economic and financial catastrophe. A default would raise the cost of borrowing into perpetuity.”

President Biden has called top lawmakers from both sides of the isle to the White House for a meeting on May 9 to try to forge an agreement for a debt limit increase.

The situation remains tenuous, with extremely high stakes. As investors, how should we think about this?

The bond fund manager PIMCO has a group of researchers dedicated to understanding how public policy impacts financial markets, and they recently shared their thinking on the debt ceiling.

Here are some takeaways on the debt ceiling issue from a recent PIMCO note:

  • More than 70% of Americans support avoiding a default, even without spending cuts – according to a recent CBS News / YouGov poll
  • Because popular sentiment supports raising the debt ceiling, default is not a political winner, and leadership on both sides of the aisle know this
  • If past is prologue, a resolution will likely happen at the eleventh hour and only after some brinksmanship
  • The average peak-to-trough performance of the S&P 500 in the month before a debt ceiling resolution over the past dozen years has been about -6.5%
  • A debt ceiling deal is the most likely outcome

From my perspective, it is inadvisable to significantly alter long-term investment strategies designed to support long-term financial plans, in anticipation of political events, especially those that have a low likelihood of transpiring.

The key to managing through possible larger-than-normal stock and bond price swings is to hold enough in liquid reserves (cash and short-term investments like money markets and short-term bond funds) to meet your near-term cash needs.

RK

Donna Cournoyer
In Economy

Another Bank Bites the Dust

Turmoil in the banking sector persisted throughout April and continues into May.

As deposit flight persisted at First Republic Bank, the pressure on the bank’s financial situation proved untenable. During the last trading day of April, the bank’s stock price cratered.

Over the weekend, regulators seized First Republic, and after a short bidding process, sold the lender to JP Morgan before the markets opened on Monday, May 1.

Three of the four largest-ever U.S. bank failures have occurred in the past two months. First Republic, which had more than $250 billion in assets at the end of the first quarter, ranks just behind the 2008 collapse of Washington Mutual Inc. Rounding out the top four are Silicon Valley Bank and Signature Bank, both of which failed in March.

While the immediate crisis may be over for the largest US banks, trouble still seems to be bubbling for mid-sized and smaller regional lenders. Los Angeles-based PacWest Bancorp, which had over $40 billion in assets at year-end 2022, experienced a precipitous stock price drop in the past week and is said to be ‘exploring strategic options’.

Persistent problems in the financial sector can be a source of concern for everyone. For folks who’ve been saving and investing for a while, worry about a 2008 financial crisis re-run in 2023 is understandable.

Key points to keep in mind, and reasons to believe that the US financial system is on firmer footing today, are:

  • The biggest US banks are better fortified compared to fifteen years ago, with significant liquidity and healthy balance sheets
  • Regulatory and private sector action has helped contain damage through swift wind downs of troubled institutions
  • Shareholders of the failed banks have borne losses
  • Most importantly, depositors have been protected

For a more in-depth explanation of what’s going on in the financial sector, I found the most recent memo from Howard Marks, Lessons from Silicon Valley Bank, to be helpful.

Marks has been investing in the credit markets for decades and is a sort of ‘Warren Buffet of Bonds’. He believes that another widespread banking crisis, a-la-2008, is unlikely.

In addition to gaining a degree of reassurance from his analysis, I found Marks’ perspective on the psychology of what’s going on to be particularly insightful. He concludes his memo by saying:

“When psychology swings in the direction of hopelessness, it becomes reasonable to believe that bargain hunters and providers of capital (i.e., investors with a long-term perspective) will be holding the better cards and will have opportunities for better returns.”

RK

Donna Cournoyer
In Investment Strategy

From TINA to BANANA: The Benefits of Higher Bond Yields

On Wednesday, May 3, the Federal Reserve delivered the 10th interest rate hike since beginning its fight against inflation in earnest in March 2022. The latest action pushed the Fed Funds short-term interest rate above 5% for the first time in 15 years.

In his press conference following the rate hike announcement, Fed Chair Jerome Powell indicated that he expects the economy to slow down and inflation to continue to decline in 2023.

This implies that the Fed likely will be able to take a break from boosting short-term interest rates soon, and that we may be in for an extended period of Fed inaction.

In this note I share some perspective on what a pause after a period of interest rate increases means for investors holding bonds and bond funds.

In the months and quarters following the pandemic, Wall Street people often used the acronym TINA (There Is No Alternative) when referring to stocks.

After interest rates dropped to the floor in 2020, and stayed there for some time, bonds offered little by way of returns, while many stocks and stock funds paid dividends and appreciated in price, especially in 2020 and 2021.

In 2022, the financial markets turned from TINA to TONR (There’s Only Negative Return) as investors suffered through high inflation, rising interest rates, and stock and bond bear markets.

However, the change in the interest rate environment, which started in 2021 and accelerated in 2022, brought a benefit, by way of higher yields, that improves the long-term outlook for bond fund holders.

In 2023, we’ve got BANANA – Bonds Are Now A Nice Alternative. In some cases, bonds and bond funds now present compelling yields with satisfactory total return potential.

The chart below compares where yields were for different types of bonds two years ago (in early March 2021) with where yields are today, following a period of inflation-fighting by the Federal Reserve.

The sharp yield increase resulted in a steep decline in bond prices in 2022. What does this mean for investors going forward?

DoubleLine, the bond fund manager, has done some research on this topic. Their analysis shows that the prospects for positive returns from bond fund holdings, in years following sharp yield rises (and corresponding price drops) is quite good.

The average price of bonds in the Bloomberg US Aggregate Bond Index (a broad measure of High Quality Corporate and Government bonds) going back to its inception in 1977 is $100. Today, the average price is in the low $90s.

According to DoubleLine, investing in High Quality bonds when the average price of the index is between $90 – $100 has typically meant returns of between 5% – 10% during the next 12 months. In years following sharp yield increases, bond returns historically have been positive.

While 2022 was painful for bond fund holders, the next several years (assuming the average bond price remains below $100) may be more pleasurable for investors who have significant bond allocations in their portfolios.

 

Donna Cournoyer
In Market Updates

April 2023 Recap: Stocks’ Sunny Outlook

Despite April showers, the financial markets maintained their sunny outlook.

For the month of April, the S&P 500 index of large company US stocks rose by 1.6%. Foreign stocks climbed higher still, up by 2.9%, helped by a US dollar that weakened against other major currencies. Year-to-date as of April 30, US stocks gained 9.2% and foreign stocks were up by 12.2%

Bonds rose along with stocks. The Bloomberg US Aggregate Bond Index rose by 0.6% last month. Through the end of April, the bond market rally in 2023 translated to a gain of 4.2%.

Below is a summary of April returns.

RK

Donna Cournoyer
In Reading Recommendations

Happy Earth Day!

Every year on April 22, Earth Day marks the anniversary of the birth of the modern environmental movement in 1970.

While not an official holiday, many folks choose to celebrate their respect for the environment by participating in events that increase public awareness of environmental concerns.

One topic that I’ve chosen to learn more about is Environmental Justice.

Michael Regan, who currently heads the US Environmental Protection Agency, has articulated the concept well in saying: “every person has the right to clean air, clean water and a healthier life, no matter how much money they have in their pockets, the color of their skin, or the community they live in.”

In searching on the topic, I came across the book Environmental Justice and Resiliency in an Age of Uncertainty, published in 2022 and edited by Celeste Murphy-Greene, a faculty member at UVA who focuses on Sustainability and Environmental Justice.

Murphy-Greene provides a framework for thinking about environmental issues by approaching them through a social justice lens. Topics of the book include an overview of Environmental Justice, Climate Justice, Health Equity, Smart Cities, Local Clean Energy, and the role that Public Works and Public Procurement can play in promoting Environmental Justice.

Murphy-Greene says her interest in environmental issues began as a college student when she was lifeguarding in Falmouth, Massachusetts and witnessed a large amount of medical waste wash ashore after a New York City-based barge dumped its contents.

On a different pedagogical note, I recently enjoyed watching My Octopus Teacher, an Academy Award winner from 2021 for Best Documentary Feature, which provides a personal account of filmmaker Craig Foster’s interactions with an octopus.

Foster was inspired to found Sea Change Project, which is dedicated to helping people understand human inter-connectedness with the natural world and to raising awareness for the Great African Seaforest.

You can see a trailer for the film and learn more about Foster’s initiatives at Sea Change Project website.

Happy Earth Day!

Donna Cournoyer
In Financial Planning

Social Security Situation: Preparing for Potential Benefit Changes

Social Security has been around since 1935 and was designed as a contributory system where workers pay into a fund that will provide benefits when they retire.

The program has two parts: Old-Age and Survivors Insurance (OASI) and Disability Insurance (DI), each supported by a Trust Fund and overseen by a Board of Trustees.

The Social Security Act requires that the Trustees report annually to Congress on the actuarial status and financial operations of OASI and DI Trust Funds. The latest report was released on March 31, 2023.

Issues regarding the long-term health of Social Security have been raised by the Trustees responsible for the Social Security system.

Having some perspective on the current state of the fund, and its future solvency, is important for retirees who receive benefits, and for those who expect to rely on benefits in the future.

At the end of 2022, OASI and DI were providing benefits to about 66 million people, and during the year, an estimated 181 million people had earnings covered by Social Security and paid payroll taxes on those earnings.

The total cost of the program in 2022 was $1.244 trillion, and total income was $1.222 trillion. Income comes from two sources: non-interest income (contributions from workers) which was about 95% of total income, and interest earned on investments, which accounts for the remaining 5%.

Under the Trustees’ current assumptions, Social Security’s total cost is projected to be higher than its total income in 2023 and all later years. Total cost first exceeded total income in 2021.

From an actuarial standpoint, the Social Security program remains solvent for the next ten years. The chart below from the Social Security Administration shows the projected Trust Fund balance through 2033.

The problem is that, unless changes to the system are made soon, the Trust fund reserves will be depleted by 2034 and collections from workers will not be enough to maintain the benefits of recipients.

The reason for the impending depletion is demographics: the retirement of Baby Boomers is increasing the number of beneficiaries faster than the increase in the number of workers paying into the system.

To put the Trust fund and the system on a path of long-term sustainability (which the actuaries define as the next 75 years), the Trustees suggest the following:

  1. Revenue would have to increase by an amount equivalent to an immediate and permanent payroll tax increase of 3.44 percentage points, to 15.84%;
  2. Or scheduled benefits would have to be reduced by an amount equivalent to an immediate and permanent reduction of 21.3% applied to all current and future beneficiaries
  3. Or scheduled benefits would have to be reduced by 25.4% if applied only to those who become eligible for benefits in 2023 or later
  4. Or some combination of the above

The Trustees conclude with a call to action for lawmakers to address the projected Trust fund shortfalls in a timely way so that necessary changes can be phased in gradually to give workers and beneficiaries time to adjust to the changes.

The Trustees’ sentiment of giving workers and retirees time to prepare and adjust to impending changes is prudent.

Demographics are unlikely to change quickly, and the action that Congress decides to take (or not take) is unknowable. The proverbial “can” could be kicked down the road by politicians for several years until the problems become more acute.

One way to prepare for potential future changes to Social Security benefits is to ‘stress test’ your financial plan. Our MoneyGuide financial planning software allows us to do this. The Social Security module in the software facilitates testing for a range of benefits reductions and helps you see how this affects the long-term results of your financial plan.

Susan and I recognize that contemplating negative impacts to your financial plan can cause discomfort. We’re able to model different Social Security outcomes and work with you to think through financial planning options.

 Visualizing a range of outcomes and having a plan for adjusting to different circumstances prior to any change in Social Security may ease anxiety and help you look more confidently toward the next decade and beyond.

 

 

 

 

Donna Cournoyer
In Investment Strategy

How Custodial Service Providers Keep Your Assets Safe

As the bank tempest was hitting full force in March, a few clients did reach out to me to inquire about how the money that we manage for them is kept safe. Below is a summary.

Client assets managed by Moore Financial Advisors are typically custodied at Pershing LLC, and Shareholders Service Group is a broker that also acts in an administrative capacity for client accounts.

Client assets are kept safe through the following:

  • Segregation of Assets: client assets are segregated from Pershing’s (custodian) and Shareholders Service Group’s (broker) assets. Unlike with checking and savings accounts at your bank, which are obligations of the bank, the assets in brokerage accounts, Trusts, and IRAs are legally separate from the assets of the custodian and broker that oversee them on clients’ behalf
  • Financial Strength: Pershing is part of BNY Mellon. The stand-alone financial strength of BNY Mellon is high. Two of the major credit rating agencies, Moody’s and Standard and Poor’s, assign a “AA” credit rating to BNY Mellon. (The highest ratings tier is AAA.)
  • FDIC Insurance: uninvested cash in client accounts is typically held in the Dreyfus Insured Deposits program. Dreyfus is a subsidiary of BNY Mellon. Dreyfus Insured Deposits benefit from the $250,000 Federal Deposit Insurance Corporation (FDIC) guarantee.
  • SIPC Insurance: Investments in Pershing accounts are protected by Securities Investor Protection Corporation (SIPC) coverage of up to $500,000. Pershing also provides coverage in excess of SIPC limits from commercial insurers.
  • About SIPC Insurance: this covers investors if Pershing were to fail and client assets cannot be located due to theft, misplacement, or destruction.

If you have additional questions regarding the safe-keeping of your assets, please send a message to Susan or me and we’ll gladly address your inquires.

Donna Cournoyer
In Economy

Bank Turmoil is a Tempest, Not a Tsunami

The turmoil from the mid-March banking crisis seems to have calmed down in early April.

To get a better understanding of what’s going on and how concerned we should be, it can be helpful to hear an insider’s point of view.

It just so happens that the nation’s preeminent banker, Jamie Dimon, at the country’s largest bank, JP Morgan, discussed the matter in his latest letter sent last week to shareholders.

I’ve found Dimon’s communications to be refreshingly plain-spoken for a big-deal financial person, and he has the respect of his peers, as he was Treasury Secretary Janet Yellen’s first call when problems surfaced in mid-March.

Here are key points on the current banking crisis from the JP Morgan Annual Report, penned by Dimon, that provide a degree of comfort that the March tempest is unlikely to be a precursor to a 2008-style tsunami:

  • The current crisis was the result of regulatory shortcomings and risk-management failures at a handful of banks
  • The most prominent risks were hiding in plain sight, including interest rate exposure and uninsured deposits
  • The current crisis is not yet over, and there will be repercussions from it for years to come (tighter regulation likely will follow)
  • However, recent events are nothing like what occurred in the 2008 global financial crisis (which barely affected smaller banks)
  • Back then, the trigger was $1 trillion of consumer mortgages that went bad, held by many financial institutions, and included the accelerant of enormous leverage (excess debt)
  • Today’s crisis involves far fewer players and fewer issues that need to be resolved

If you’re interested in hearing his take on the recent bank issues, you can watch Dimon’s CNN interview.

From my perspective, to be confident that a banking crises has been resolved, we typically need to see three conditions met:

  1. Government support
  2. Resolution of failed entities
  3. Passage of time (with no additional failures)

We have seen significant government support through a new Federal Reserve lending program and the swift resolution of three of the failed entities – Silvergate Bank, Signature Bank, and Silicon Valley Bank. Also a large foreign bank, Credit Suisse, was taken over by its main competitor, UBS, following governmental intervention.

As for the third condition: if summer arrives without additional failures, I’ll feel comfortable calling “all clear”.

Donna Cournoyer
In Market Updates

March 2023 Recap: Two Good Quarters

Despite recent problems in the banking sector, stocks started the year on a strong note.

The US benchmark S&P 500 gained 7.5% in the first quarter of 2023. Foreign stocks also climbed, with the EAFE Index (Europe, Australasia and the Far East) up 9%. Technology stocks had a stellar quarter, rising by nearly 21%. Bank stocks were on the other end of the spectrum, falling by more than 17%.

And bonds participated in the rally, too. A near half-of-one-percentage-point drop in intermediate-term interest rates—despite short-term rate increases by the Federal Reserve in January and March—translated to a gain of 3.2% for the Bloomberg Aggregate Bond Index, a key gauge of the US bond market.

Here’s a recap of stock and bond performance by quarter, going back to the beginning of last year.

RK

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