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Second Quarter Newsletter

Responsible Guidance:  Second Quarter 2022 Newsletter, July 2022

Are the current economic and market issues impacting your financial behavior?

You probably know the stock market is down this year. You may also know the bond market is negative.

We did a Google search for “how often does the stock market go down?”.  Eyeballing the most popular results from the search suggests the stock market goes down, on average, one in every four years.  Looking at performance over the last four years, that statistic looks solid, based on where we are so far, this year.  Of course, the year is not over, and the sample size is too small to draw a meaningful conclusion.  Expanding our data, since 1990, the S&P 500 has had only six completed years with negative performance.  This is better than the one in four chance the Google search results suggest.  In only three of those years, since 1990, was performance down more than 10%.  So far this year investors are feeling a little more pain than normal.  

Unfortunately, we cannot control or consistently predict market movements.  But we can control our behavior in different market environments.  There is a study based on reactions to different market environments, known as Behavioral Finance.  At Baron, we spend a lot of time on this subject.  Behavioral Finance starts with assumptions that people are not always rational or willing to make tough decisions, even if it is in their best interest.  Understanding the many different biases within Behavioral Finance, can help you improve the actions you do take or help avoid taking the wrong actions.

A bias that may resonate with people currently is recency bias.  This occurs when too much emphasis is placed on recent events, such as thinking a market downturn will continue forever.  This bias can cause short-term decisions that are not consistent with your financial plan and have negative long-term impacts.

We are not pointing out recency bias because we think markets cannot go down further from here, they can.  We point it out, because assuming markets will only go down, or assuming the current environment will continue forever, ignores many different statistically possible outcomes.  Recency bias can lead to destructive actions.

As you read the economic and market data below, it is not positive.  Hopefully, you have seen and heard from us about the actions we are taking for you that are not based on behavioral biases but on Your Personal EconomySM – review the impact of your financial plan considering many different market environments, test the quality of the investments, rebalance where needed, take advantage of tax trading opportunities, etc.

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 15.85% in the second quarter, as equity performance continued to struggle with concerns about inflation, interest rates, economic growth, and geopolitical risks.  The negative performance in the second quarter pushed performance further downward to negative 20.46% year-to-date (YTD). 

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 second quarter, down 8.91%, mostly tied to the same concerns equity investors are facing.  YTD, performance is down 14.79%. 

U.S. Economy

The economic data we follow reflects a slowdown in economic growth for the U.S. economy, though the job market remains strong.  Up-to-date economic information like stock prices, the shape of the yield curve, housing construction and consumer appetite reflect either uncertainty or negativity.  As mentioned, challenges related to inflation, interest rates, and geopolitical risks all remain areas of concern.

The Bureau of Economic Analysis (BEA) announced in its third estimate for the first quarter of 2022 that real Gross Domestic Product (GDP) decreased at an annual rate of 1.6%.  The decrease came as a small surprise to economists and was mostly driven by a decrease in exports, federal government spending, private inventory investment and state and local government spending, while imports, which negatively impact GDP, increased (full press release can be found at https://www.bea.gov ).

Most economists define a recession by two consecutive quarters of negative GDP.  As we approach the release of the first estimate of second quarter GDP (expected July 28, 2022), many are speculating whether we are officially in a recession or not.

Due to the normal delay in receiving growth data from the BEA, the Federal Reserve Bank of Atlanta now publishes a “nowcast” by estimating GDP growth for the most recent quarter (in this case the second quarter of 2022) using an approach similar to the BEA.  The “nowcast,” along with the methodology, and additional information can be found at:   https://www.atlantafed.org/cqer/research/gdpnow

On July 19, 2022, the estimate for second quarter GDP from the Federal Reserve Bank of Atlanta was negative 1.6%.  If the estimate becomes accurate, the U.S. economy would officially be in a recession for the first half of 2022.  Note that this estimate is updated regularly and is subject to change.  The next estimate, as of this writing, will be on July 27th. 

Job growth is one area in the economy that remains strong.  According to the Bureau of Labor Statistics (BLS), the U.S. gained 372,000 jobs for the month of June, and the unemployment rate remained below 4%, at 3.6%.  BLS suggests that job growth was notable in professional and business services, leisure and hospitality, and healthcare (full press release can be found at:  https://www.bls.gov).

U.S. Stocks

The S&P 500, an index consisting of 500 of the largest U.S. domestic stocks, was down 16.10% in the second quarter of 2022, pulling YTD performance down to negative 19.96%.  For technical analysts and trend followers, the index spent most of the time below the 200-day moving average, where it finished the quarter. 

Dividing index components into growth and value, value continued to outperform in the second quarter.  Many stocks characterized as value stocks, tend to pay more dividends, relative to growth stocks, that typically use "excess" cash to reinvest and expand their business.  With inflation and interest rates increasing, investors have been favoring stocks that return capital faster to investors through dividends, benefiting value stocks.

International Stocks

International developed country equities (such as those in the European Union), measured by the MSCI EAFE index was down 14.51% in the second quarter and down 19.57% YTD.  Non-developed, or emerging countries measured by the MSCI EM index, was down 11.45% for the quarter and 17.63% YTD.  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, yet those benchmarks have done better YTD than our benchmark for U.S. stocks, the S&P 500.      


U.S. Domestic Fixed Income (bonds), as measured by the Barclays U.S. Aggregate Bond Index, was down 4.69% in the second quarter and down 10.35% YTD.  The index gauges the performance of investment grade intermediate bonds.  With concerns of inflation fears and the Fed increasing interest rates, the index continued to struggle.

The 10-year U.S. Treasury bond yield was at 2.98% at the end of the second quarter, as rates continued an upward path.  The benchmark bond yield was 2.32% at the end of the first quarter and began the year even lower at 1.52%.

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 second quarter finished with the 2-year rate jumping to 2.80% which was significantly higher than where it ended 2021 at 0.73%.  The 10-year, as mentioned, was 2.98%.  During the second quarter, the move up in short-term rates was less than the increase in long-term rates, causing the curve to steepen.  The spread between the 2-year and 10-year finished the quarter at 18-basis points.  With a relatively flat yield curve, direction for growth in the economy remains uncertain and conversations continue about concerns of the yield curve inverting.  The 18-basis point spread (a basis point represents 1/100 of 1%) was much lower than 79-basis points at the end of 2021. 

Housing and Real Estate

Commercial real estate, as measured by the FTSE NAREIT All Equity REIT (Real Estate Investment Trust) Index fell 14.68% in the second quarter and is down 19.17% YTD.  The lower performance this year follows the staggering 41.30% positive return in 2021. 

According to Freddie Mac (FM), the average 30-year residential home mortgage rate jumped to 5.30% with 0.8 Fees/Points, well above the rate of 3.45%, with 0.7 Fees/Points recorded near the beginning of the year.  The rate is subject to change and may not be offered in all areas or to all borrowers. 

Natural Resources

The Bloomberg Commodity Index (BCOM) fell 5.66% in the second quarter, bringing performance down to 18.44% YTD.  This index is the only positive performer YTD of the indexes we cover for this letter.  The slowdown in pricing during the second quarter though, hopefully reflects a potential slowdown in inflation as the year progresses. 

 Baron Client Strategies

Planning for multiple outcomes with Your Personal EconomySM is critical to helping our clients answer the simple questions like "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 globally-diversified strategy.  Also, 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.    

When markets experience a downturn, two strategies, outside of your investment strategy, to consider are tax-loss trading and Roth Conversions.  We discussed tax-loss trading in our first quarter newsletter.  As markets continued negative performance during the second quarter, you may have noticed discussions of Roth Conversions increasing.  That is because down markets present an opportunity to convert depressed assets in an IRA account, which is tax-deferred, into a Roth account, which is tax-exempt. If the depressed assets recover in the Roth, the value of the account, including the appreciation, is completely tax-free. Unfortunately, Roth Conversions are not for everyone.  The decision to convert requires thoughtful analysis and review of tax implications. 

If you are in a relatively low tax bracket in 2022 and currently have tax-deferred savings in a traditional IRA account, you may consider rolling some, or all, of those assets into a Roth IRA account.  There will be tax consequences for the year of the conversion.  But by converting, you will help diversify your future tax situation and create an opportunity to potentially grow an investment account without any future tax implications.  Asset location is an important consideration for a Roth account.

If you are interested and want to learn more, please reach out to us to discuss.

Concluding Comments

Do not let behavioral biases creep into your financial decision-making, especially when markets are not doing well.  It is best to have a plan in place that deals with several possible market outcomes and understand how those outcomes impact you and Your Personal EconomySM.

Baron Updates  

Baron is committed to keeping your personal information safe and educating you on how to remain vigilant.  Please read our blog post with a communication from Schwab regarding how to protect yourself from potential scams. 

Another 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.

In addition to helping clients with their financial lives, we are always happy to help in other ways, as well.  Keep in mind that you can always come to our Fair Lawn office to use our copying, shredding, and notary services.  Just reach out to us if you wish to come in and take advantage of those services.

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 info@baron-financial.com to enroll.

For 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.

We are proud to continue our annual Baron Financial Group Scholarship, in its 12th consecutive year, awarded to two deserving Fair Lawn High School graduates continuing their education in a business program.  This year we are happy to help sponsor the Adopt-a-Soldier Platoon’s Salute to American Heroes Gala Event on October 20, 2022.  You can read more about both the scholarship and the sponsorship on our blog.

As most of you may know, Johanna, one of our client relationship specialists, has left her position at Baron to pursue her passion for education.  She will be starting a doctoral program this fall at UNLV in Nevada, studying Geoscience. We miss her and wish her continued success! Your advisor team will remain the same.

Save the date - we hope to see you at our Client Appreciation Event in NJ on September 22nd!

Warmest Regards,

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 July 19, 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.