First Quarter Newsletter
Responsible Guidance: First Quarter 2022 Newsletter, April 2022
The real risks come from things we do not know. So, what should you do?
In 2019, the U.S. bond yield curve inverted (see Bonds section for explanation). An inverted yield curve has been a good predictor that a recession is coming. In 2020, we did experience an economic slowdown, but that slowdown was a result of purposefully shutting down economies as part of an effort to slow the spread of Coronavirus. We think it would be a reach to say bond investors, or any other investor, knew a pandemic was coming, which we feel was the real reason negative economic growth materialized in 2020.
The known risks in 2019, prior to the pandemic, were surrounded by concerns about the future, including concerns about Fed policy related to inflation and interest rates. But the U.S. economy at the end of 2019 was good overall, jobs and the economy were growing, and unemployment was 3.5%. Flash forward to today, jobs and the economy are growing, and unemployment is low (3.6% most recent reading). The known risks today center around Fed policy, the Russian-Ukraine conflict, and still lingering pandemic fears. If the economy does slow down from here, these may be factors, but more than likely, the true downward drive will be caused by something not yet known. That is why we feel making predictions is difficult.
We do not know if an economic downturn is coming, and we are not suggesting one is. They are part of investing, though, and you should know how economic downturns impact Your Personal EconomySM. And it is not only important to plan for downturns, but also for upside surprises. Bottom line is you should be prepared for a range of possible economic outcomes. Control the controllable, have a risk-appropriate diversified strategy, have a spending plan, and evaluate your financial position in different economic environments. If you are not sure how Your Personal EconomySM is positioned in different economic environments, reach out to us and ask.
A Global Perspective
A core objective for our customized Baron Financial Group investment strategies is global diversification. Global diversification means including investments based both domestically in the U.S., as well as internationally in developed and developing countries.
There are popular benchmark indexes that provide perspectives about performance of global investments. For equities, we monitor the MSCI ACWI All Cap Index. This index is designed to represent equity investments across 23 developed and 24 emerging markets. The index was down 5.48% in the first quarter, as equity performance struggled with concerns about geopolitical risks, inflation, and interest rates. For fixed income, or bonds, we track the FTSE World Government Bond Index. The index tracks sovereign debt from 20 countries, denominated in their respective currencies. It was negative in the first quarter, down 6.46%, mostly tied to the same concerns equity investors are facing.
The economic data we follow in our newsletter suggest a positive U.S. economy. Within the data, some of the momentum has been shifting. On the plus side, economic growth continues, the Leading Economic Index’s most current reading is positive, the job market remains strong, and consumers remain confident, mostly due to the job market. Challenges related to the pandemic, inflation, interest rates, and geopolitical risks surrounding the Russian invasion of Ukraine, all remain areas of concern.
The Bureau of Economic Analysis (BEA) announced in its third estimate for the fourth quarter of 2021 that real Gross Domestic Product (GDP) increased at a 6.9% annual rate, following the 2.3% growth reported for the third quarter of 2021.
The BEA regularly releases a note with GDP data. The note can be found on their website at www.bea.gov. “The increase in fourth quarter GDP reflected the continued economic impact of the COVID-19 pandemic. In the fourth quarter, COVID-19 cases resulted in continued restrictions and disruptions in the operations of establishments in some parts of the country. Government assistance payments in the form of forgivable loans to businesses, grants to state and local governments, and social benefits to households all decreased as provisions of several federal programs expired or tapered off. The full economic effects of the COVID-19 pandemic cannot be quantified in the GDP estimate for the fourth quarter because the impacts are generally embedded in source data and cannot be separately identified. For more information, refer to the Technical Note and Federal Recovery Programs and BEA Statistics.”
GDP is a measurement of what has already happened. There are, however, statistical measures that give insight into the future. One of those measures is The Conference Board Leading Economic Index® (LEI) for the U.S. The index is an analytical tool that helps signal peaks and troughs in the business cycle. The February LEI, released on March 18th, improved to 119.9 (2016 = 100), following a decreased reading for January.
“The US LEI rose slightly in February, partially reversing January’s decline,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “However, the latest results do not reflect the full impact of the Russian invasion of Ukraine, which could lower the trajectory for the US LEI and signal slower-than-anticipated economic growth in the first half of the year. The global economic impact of the war on supply chains and soaring energy, food, and metals prices—coupled with rising interest rates, existing labor shortages, and high inflation—all pose headwinds to US economic growth. While the Omicron wave and its economic impact waned in recent months, the potential for new COVID-19 variants remains. Amid these risks, The Conference Board revised its growth projection for the US economy down to 3.0 percent year-over-year GDP growth in 2022— still well above the pre-pandemic growth rate, which averaged around 2 percent.”
In previous newsletters, we have included a chart that tracks LEI over time, and highlights periods of recessions on the chart. Typically, the LEI declines significantly in advance of a recession. At this time, the chart is not available. The raw data for the chart (LEI and Coincident Economic Index (CEI)) were both tracking upward for the most recent data points. Using these factors alone, one might expect economic growth to continue for now.
According to the Bureau of Labor Statistics (BLS), the U.S. gained 431,000 jobs for the month of March, and the unemployment rate remained below 4%, at 3.6%. BLS suggests that job growth was notable in leisure and hospitality, professional and business services, retail trade, and manufacturing.
The Conference Board Consumer Confidence Index® increased in March to 107.2 (1985 = 100).
“Consumer confidence was up slightly in March after declines in February and January,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “The Present Situation Index rose substantially, suggesting economic growth continued into late Q1. Expectations, on the other hand, weakened further with consumers citing rising prices, especially at the gas pump, and the war in Ukraine as factors. Meanwhile, purchasing intentions for big-ticket items like automobiles have softened somewhat over the past few months as expectations for interest rates have risen.”
“Nevertheless, consumer confidence continues to be supported by strong employment growth and thus has been holding up remarkably well despite geopolitical uncertainties and expectations for inflation over the next 12 months reaching 7.9 percent—an all-time high. However, these headwinds are expected to persist in the short term and may potentially dampen confidence as well as cool spending further in the months ahead.”
The S&P 500, an index consisting of 500 of the largest U.S. domestic stocks, was down 4.60% in the first quarter of 2022. For technical analysts and trend followers, the index spent time during the quarter below the 200-day moving average but finished the quarter above that popular trend line. Dividing index components into growth and value, value outperformed in the first quarter. Many stocks characterized as value stocks, tend to pay more dividends, relatively, than growth stocks, who typically use "excess" cash to reinvest and expand the business. With inflation and interest rates increasing, investors may have been favoring stocks that return capital faster to investors through dividends benefiting value stocks.
International developed country equities (such as those in the European Union), measured by the MSCI EAFE index was down 5.91% in the first quarter. Non-developed, or emerging countries measured by the MSCI EM index, was down 6.97% for the quarter. These international stock benchmark indexes both underperformed the S&P 500 to start 2022. Many economies outside the U.S are experiencing similar inflation and interest rate challenges and the Russia-Ukraine conflict hits a little closer to home for the European countries.
U.S. Domestic Fixed Income (bonds), as measured by the Barclays U.S. Aggregate Bond Index, was down 5.93% in the first quarter. The index gauges the performance of investment grade intermediate bonds. With concerns of inflation fears and Fed starting to increase interest rates, the index struggled with performance, not much different than major equity indexes over the same time.
The 10-year U.S. Treasury bond yield was at 2.32% at the end of the first quarter - higher than 1.52%, when the year started. The move higher in rates does seem consistent with the growth in the economy and the Federal Reserve's current interest rate policy actions.
If you plot interest rates versus the time-to-maturity to earn those rates, you have created a yield curve. We continue to monitor the changing shape of the yield curve for U.S. debt issues, and what that may signal. Specifically, we follow the shape of the yield curve (plot of interest rates for different time periods). Using the U.S. Government 2-year bond rate as a proxy for short-term rates and the 10-year U.S. Government bond rate as a proxy for long-term rates, we calculate the difference between the rates, which provides a possible indicator for the future direction of the economy. A steep spread (long-term rates higher than short-term rates) indicates potential future economic expansion and fixed-income investors are compensated for taking longer-term risk. A flat spread (long-term rates match short-term rates) is a possible indicator of economic uncertainty and longer-term investors are not being compensated for investing in longer-dated securities. An inverted spread (short-term rates are higher than long-term rates) possibly indicates future economic contraction.
The first quarter finished with the 2-year rate jumping to 2.28%, which was significantly higher than where it ended 2021 at 0.73%. The 10-year, as mentioned, was 2.32%. The move up in short-term rates was greater than the increase in long-term rates, causing the curve to flatten to 4-basis points. The flat yield caused a lot of quarter-end discussions about concerns of the yield curve inverting. The 4-basis point spread (a basis point represents 1/100 of 1%) was much lower at 79-basis points at the end of 2021. We think the flat yield curve reflects the bond market’s uncertainty about the direction of future economic growth.
Housing and Real Estate
Commercial real estate, as measured by the FTSE NAREIT All Equity REIT (Real Estate Investment Trust) Index fell 7.13% in the first quarter of 2022, after being up a staggering 41.30% in 2021. This was the worst performing index that we cover in our newsletter to start 2022; last year it was the best performing.
According to Freddie Mac (FM), the average 30-year residential home mortgage rate jumped to 5.11% with 0.8 Fees/Points, well above the rate of 3.45%, with 0.7 Fees/Points recorded in our last newsletter. The rate is subject to change and may not be offered in all areas or to all borrowers. The current rate eclipses the rate we reported two years ago, at the start of 2019, of 4.51% (close to a seven-year high at the time).
The Bloomberg Commodity Index (BCOM) jumped 25.55% in the first quarter. Not only was the index up huge, but it was also the only positive performer of the indexes we cover for this letter. The continued positive performance could be a positive indicator for an improving economy. But concerns of lasting inflation remain.
Baron Client Strategies
Planning for multiple outcomes with Your Personal EconomySM is critical to helping our clients answer the simple question "Am I going to be OK?".
As clients know, we are fiduciaries and operate as fee-only advisors, so there is no benefit to us for making investment transactions. The reasons we make trades are to align clients' portfolios with their customized, risk-appropriate diversified strategy, and because we believe the actions we take are potentially strengthening the clients' portfolios or financial positions. We use this same approach with our own personal money.
No matter the economic environment, our basic principles remain:
Create a globally-diversified and risk-appropriate strategy. Validate the investment choices versus peer investments. Rebalance when needed. Test the strategy in a comprehensive financial plan and obtain regular feedback to update information and advance your financial position.
Your Service Plan
One of our primary roles is to educate our clients to make informed decisions about reaching their goals. Critical to that process are plan reviews, a process that focuses our attention on your goals, takes account of any changes in your situation and allows us to alter the course, as necessary. If you have had any changes to your financial position or are considering changing financial goals and objectives, please let us know.
Your Personal Economysm
You may have heard us say that we are happy to help clients with issues outside of investing that may have an impact on their financial lives. We say things like “Lean on us when you are making a decision with anything with a dollar sign involved.” So, we have been including this section as a reminder of all our services and to share ways in which we can help clients outside of investing.
We assisted with many questions related to taxes as April 15th approached, so we think it is important to reiterate our message from our last quarterly letter.
TAXES: Everyone's tax position is unique to their specific Personal EconomySM. We recommend working with a tax professional to optimize your overall tax position. At Baron, we are sensitive to the impacts investing has on taxes and will work with our clients' tax professionals. When reasonable, we take advantage of tax-saving strategies, such as tax-loss trading, not just at the end of the year but throughout the entire year.
Tax-loss trading involves reviewing individual investments in taxable accounts that have a value lower than what the position cost. If there is a reasonably sized loss, the position can be sold, and the loss can be captured to possibly help reduce taxes. Reinvesting the funds from the sale, if possible, in a peer investment, keeps your investments best aligned within your overall investment strategy. If no peer investment choice is available, the proceeds from the sale may be reinvested in another asset class or sit in cash until the wash-sale rule is no longer in effect (30 days).
Check out Nicholas Scheibner's video on taxes located in the blog section of our website.
Control the controllable and plan for multiple scenarios as it relates to Your Personal EconomySM.
A protective measure we use for our Baron clients is the Trusted Contact form that is kept on file at Schwab and at Baron. If you have not already completed this form by assigning a trusted contact, let us know. The more recent Schwab account applications include this form.
Remember that you can visit our website to gain access to your client portal. Just click on the client-portal tab, which will allow you to view your account information. The client login requires a username and password to gain access through the portal. Please let us know if you would like to create your portal login or if you would like to learn more about what the portal provides, including paperless statements. Contact Baron at 1-866-333-6659 or at email@example.com to enroll.
If you are a client, or prospective client, you might be interested in how the Baron Advisors answered some pertinent questions about our firm – questions we feel are important to ask. Check out our “Interview Video” on our website.
For more educational content, please visit our Website Blog. The Baron Advisors are often called upon by journalists for their insights on financial planning and investing. They are quoted in such prestigious media outlets as The New York Times, CNBC.com, and NJMoneyHelp.com, among others.
As you might be aware, philanthropy is often top-of-mind for Baron. We are proud to have been honored by the SCARC (Sussex County Arc) Foundation at their annual awards gala. You can read Victor’s remarks at the gala on our website blog post. In addition to our favorite charitable donations, this quarter we felt inspired to help the brave people of Ukraine by contributing blankets and other much-needed items. We also donated to a local New Jersey youth group, that is supervised by our own James Suazo.
On a very personal note, we are thrilled to welcome our newest Baron Team member, Abigail Noelle Scheibner, born 2/2/22 to loving parents Nick and Jen Scheibner and big sister Joanna. And congratulations to Angela and Fran and their families on the engagement of Angela’s son Ryan to Stephanie and Fran’s daughter Rebecca to Alex.
Please let us know if you have any life changes that may affect your financial plan. And please share your good news - we are always happy to hear from you!
Baron Financial Group, LLC
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 14, 2022, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Baron Financial Group to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client’s investment portfolio. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. Inclusion of index information is not intended to suggest that its performance is equivalent or similar to that of the historical investments whose returns are presented or that investment with our firm is an absolute alternative to investments in the index (if such investment were possible). Investors should be aware that the referenced benchmark funds may have a different composition, volatility, risk, investment philosophy, holding times, and/or other investment-related factors that may affect the benchmark funds’ ultimate performance results. Therefore, an investor’s individual results may vary significantly from the benchmark’s performance.