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New Year, New Hope

Published on November 30, 2022

Peter Mallouk
President & CEO
Jonathan Clements Headshot

Jonathan Clements
Director of Financial Education

This month, Peter Mallouk and Jonathan Clements discuss what’s in store for 2023 and how the bear market will end. Plus, learn what Sandra Bullock movies and bear markets have in common.

Hosted by Creative Planning Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!

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Jonathan Clements: Hi, this is Jonathan Clements, the Director of Financial Education for Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, President of the firm, and we are Down the Middle. One month from now, 2022 will be in the books. We’ll say goodbye to a year that’s seen both high inflation and record low unemployment. We’ll also say goodbye to a year that’s been miserable for the stock and bond markets but offered welcome relief to those with cash investments. The question today, what does 2023 hold? Peter, let’s start with the bond market. We saw the yields on the benchmark 10-year Treasury note jump from 0.5% at the beginning of the year to above 3.5% today. We’ve also seen the yield curve invert with two-year treasuries yielding more than 10-year Treasuries. What do you think is in store for 2023?

Peter Mallouk: Well, if you look at what’s happened to the bond market, it’s been stunning. People always say they want to see higher yields in bonds. Well, here you have them, and they also wanted a lower PE ratio of stocks, they’ve got that too, but it always hurts what has to happen to get there, not just as the Treasury just about tripled in yield. If you look at high yield credit, it’s gone from under 4% to 8.5%. Emerging markets bonds from 4% to 8%. Munis from less than 2% to in many cases over 5%. It’s really been a drastic change as the Fed has really driven rates much higher, much faster. And the Fed is telling us they’re going to continue to raise rates well into the first quarter of 2023 so we can expect a little bit more of that, and then they expect to probably pause.

And the bond market thinks the same thing. The bond market is basically pricing in a couple more price hikes, but then it expects to go into a recession, and we can tell that because we can see that the yield curve is inverted, meaning that if we look further out, bond yields actually go down. You actually get paid less to loan money for a longer period of time and that would only happen if people are pessimistic over the longer run. So we see that if we look into the late 2023, the bond market expects yields to come down, but for bond investors overall, this is very, very positive. If you have income coming off your portfolio, and it’s being reinvested in the bond portion of your portfolio, you’re buying bonds that are paying double or more than double what they were paying about a year ago. If you are adding money to the portfolio and you’re adding money to the bond side of the portfolio, or you’ve got a bond ladder or bonds that are maturing and they’re being replaced with new bonds, they’re being replaced with higher yielded bonds.

No different than if you were at a bank, you had a bunch of CDs paying 1%, 2%, and as they mature, you’re going in at 3%, 4%, 5%. Very, very positive for the long-term investor. So as you see bond yields go up, current bond prices go down which is negative if you need that money this year, but if your time horizon is several years, it’s incredibly positive because it improves the overall total return of the bond portion of the portfolio.

Jonathan: So I think one thing that listeners should focus on here is if we are indeed towards the end of the great hikes by the Federal Reserve, and later in 2023, they’re going to start cutting rates, the really attractive yields that we’re seeing today on cash investments and short-term bonds are going to rapidly disappear. So if you look across the bond market today and you say, “I like these yields for the longer term,” you don’t want to necessarily be sitting there with cash investments. You want to be thinking about extending your maturities a little bit so that you lock in these higher yields. You may get less yield today than you would at the short end of the curve, but by late 2023, that may be the smart place to be and you will not only have that higher yield locked in, but also you’ll see the price your bonds rise as interest rates come down, assuming of course that everything plays out as we expect.

So meanwhile, let’s turn to the stock market. When we got October’s inflation report on November 10, investors saw hints that inflation was slowing and the S&P 500 soared 5.5% that day. To me, that was a sign for how the bear market will end. What we need is continuing evidence that inflation is easing. Do you think that’s right, Peter?

Peter: I do think it’s right. I think the main issue that’s been at the forefront of the market this entire year, and is going to stay the same for the rest of the year, is inflation. The market has to see inflation under control because it knows, because the Fed has been very frank about it, that the Fed will continue to raise interest rates until they have controlled inflation, and controlled inflation means down near 2% again so we got a long, long way to go. Now, anyone that’s selling cars or anyone that’s building houses or anyone that’s selling refrigerators or washers and dryers knows that inflation is subsiding in many parts of the economy, but it’s not where it needs to be and we still have that extra $5 trillion sloshing around the economy and home prices have not given back this huge leap that they took post-COVID. And I think until we get a little bit more of a softening, the Fed is going to continue to raise rates.

This has been front and center, and higher rates, the market gets very concerned about higher rates because if it costs more to borrow, you can afford less real estate, you can afford less equities, you can’t afford to invest in companies that don’t pay earnings right away. It has an impact on all sorts of investments. And so until we get interest rates under control and inflation under control, we’re going to see problems. But I think we’ve got a few other problems that are now rising up to be substantial, like if we look at what’s going on in China right now, every now and then, you’d see a protest somewhere in China, but you have to go back to 1989 to see what you see in China today, which is protests across the country and talking about changing the government. This is something that takes a lot of guts in China.

You really have had to have had it to put your life at risk in that way. If that unrest there, so many things come out of China in this global supply chain, if we see disruption in the supply chain that’s just now beginning to recover in China, we’re going to have big market problems too even if we get inflation under control. So I think there are always other issues. The market’s always facing a bunch of issues, war, energy, prices, everything else, because there are many times where we’re not worried about inflation, but inflation is the centerpiece now but there are a lot of other issues that are concerning as well.

Jonathan: So speaking about this situation in China, Peter, we know what drives markets in the end is news, at least in the short term. When the news is worse than expected, so is the performance of the stock market and the reverse of course is also true. So we look ahead to 2023. Obviously, we can’t predict the news but can you think about what are the issues that we should be watching and that are going to drive the market in the short term, depending on whether the news turns out to be more or less pleasant than expected?

Peter: Yeah, you’re exactly right. In the short run, lots of things matter. China, lockdowns, supply chain, Ukraine, Russia, energy prices, interest rates, inflation. In the short run, all of these things matter and you do your best to navigate your way through them. In the long run, only one thing matters and that’s earnings. And if we look at what drives earnings over the long run, do we have people to buy things? And we do. We have over a billion people coming out of poverty over the next 10 years, and innovation and technology drive earnings, and are we innovating? Of course we are. We’re innovating at a pace that they’ll be writing about in history books a thousand years from now. So in the long run it’s very easy to be very, very optimistic. In the short run, as always, it’s incredibly unpredictable. We’re just constantly swapping out what the three or four issues of the day may be.

Jonathan: I think that’s right, but I think that investors should be reassured by what is in prospect. We don’t know what the timeline is. We know what it’s going to look like. We know that if inflation starts to slow, the Fed will have the room to stop increasing rates and maybe start to cut them, and as that happens, not only is the bond market going to improve substantially, we’re also going to see the stock market pick up. We’ve already seen a glimpse of that this year, and if that continues in through 2023, at some point, we are going to see a significant stock market rally. It’s just a question of is it going to come sooner rather than later? I think we’ve seen the future, we just don’t know when it’s going to happen.

Peter: That’s exactly right. What I tell my clients is this is like a Sandra Bullock movie. It’s always a little bit different. The plot’s a little bit different. I know how it’s going to end. It’s going to be a happy ending, right? It always works itself out.

Jonathan: And that’s why we watch Sandra Bullock movies. We want the happy ending. All right, Peter. So we still have a month left in 2022 and that offers a segue into our financial wellness tip of the month. Peter, what year-end planning tips would you offer to listeners?

Peter: So we get a couple of free passes when it comes to financial planning and a lot of those have to do with not paying taxes today that you don’t have to pay today or putting money in accounts where they grow tax free. And so make sure that you’ve maxed out to the extent that you’re able all of the opportunities available to you, so that would mean a Roth IRA, or if you’re not eligible for that, a traditional IRA, health savings accounts and a 401(k) — especially if you have an employer match, make sure you don’t leave that on the table, a guaranteed a 100% rate of return. Fill up all those buckets as best as you can. And bonus tip, if you’ve got kids that are minors or if you’ve got kids and they have earnings throughout the year, you can open a Roth IRA for them and contribute on their behalf or they can contribute up to the amount they’ve earned up to $6,000 as well.

Jonathan: So Peter, I want to piggyback on your tip and suggest to listeners that they prepare themselves to fund these tax saving accounts for 2023 early next year. We know that funding these accounts early in the year generally makes sense because financial markets trend higher over time, but I would argue that it’s particularly smart in early 2023 because you know you’re going to be able to invest in financial markets at depressed prices. So I sit here and I look at my own finances and I think about what I want to achieve in 2023. I want to do a conversion from my traditional IRA to a Roth. I want to fund the 529 plan for my grandson, I want to fund my solo 401(k), I want to fund my health savings account. There are tens of thousands of dollars that I can invest here. My only problem is where am I going to find all the cash?

But I want to find that cash as early as possible in 2023 so that I get that money into the market as early as possible and take advantage of financial markets that, believe it or not, go higher over time. 2022 has been a bit of an exception but history will resume its march towards a better future starting next year, maybe even starting already this year.

So that’s it for this month, Peter. This is Jonathan Clements, Director of Financial Education for Creative Planning. I’ve been talking to Peter Mallouk, President of the firm, and we are Down the Middle.

Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed.

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