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The Financial Lessons of 2021

Published on December 1, 2021

Peter Mallouk
President & CEO
Jonathan Clements Headshot

Jonathan Clements
Director of Financial Education

In this episode, Peter Mallouk and Jonathan Clements reflect on what we’ve learned this year about inflation, bonds, stock performance, NFTs and other newly popular investments. Perhaps the biggest lesson of all is you can’t guess the short-term direction of either the markets or politicians.

For their monthly tips, they offer advice on using appreciated stock for your charitable gifts and why you should let your family know the reason for any monetary gifts you give them for the holidays.

Hear more about inflation concerns

Read more about NFTs and meme stocks

Hear more about cryptocurrency

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!

Have questions or topic suggestions? 

Email us @ podcasts@creativeplanning.com

Transcript:

Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education for Creative Planning, headquartered in Overland Park, Kansas. With me is Peter Mallouk, President of the firm. And we are Down the Middle. A month from now 2021 will be in the books. But what financial lessons have we learned from this year? Perhaps lesson number one is inflation isn’t extinct. Were you surprised, Peter, by how strongly inflation came back in 2021? And do you think it will also be as big a worry 12 months from now?

Peter Mallouk: Well, I think from 2021, I mean, we’ve talked about inflation ad nauseum on this, but it is the core economic issue of 2021 and probably will be going into 2022. I mean, there’s a lot of things that we really understand now, what’s going on with trucking, and ports, and people retiring early, and immigration and all of the things that are resulting in a labor shortage and supply chain issues. But I think some of this is going to carry forward into 2022. And I think that the main thing that’ll carry forward is its clear that we don’t have the virus under control. And even though in the United States more than 70% of people are vaccinated, the average thing that comes to the United States has parts made in 10 different countries. And a lot of these countries don’t have COVID under control.

And so as long as we have COVID causing problems all over the world, it is by itself going to create supply chain issues, which has an impact on inflation. I also think we have this flood of stimulus money coming in, in the form of infrastructure that will drive inflation. But, at the end of the day, over the long run, whether it’s a year from now, two or three, if Republicans and Democrats can just control spending just a little, technology is going to bring long-term inflation under control. I mean, technology creates efficiencies that drive inflation down. And so I think we’ll eventually see that deceleration of inflation, but it’s going to take a little longer than I think everyone expected.

Jonathan: So, beyond the reminder about inflation and the fact that it is far from dead, I think one of the reminders for investors is that it’s important to think in terms of real returns. Almost everybody with the savings account, almost everybody who’s an investor in high quality bonds has realized this year that you’re not making money once you factor in inflation, and you’re definitely not making money once you factor in inflation and taxes. So for everybody who wants to make their wealth growth over time, the default investment option becomes stocks because nothing else is offering you that real return, over and above the inflation rate.

And these other investments, cash investments, bonds, yeah, they’re great for portfolio insurance, but not a great way to build your wealth. So of course, thinking of bonds, another reminder from 2021, interest rates can actually go up, which feels odd after four decades of declining interest rates. While almost every category of stock fund has posted a gain so far this year, almost every category of bond fund has suffered losses. Do you think investors should be prepared for more of the same in 2022, Peter, or is this rise in rates a temporary thing?

Peter: I think the long bull market run in bonds is over. I mean, bonds are just loans. 99% of a bond’s returns is the yield from the bond. It’s a very simple rule and I think a lot of people don’t understand it. 99% of what you should expect from your bond portfolio is look at the interest rate on the bonds you’re getting and that’s what you should expect. And 80% of bonds are paying less than 2%. And what can inflate the value of a bond, besides the yield, is if interest rates go down, your bonds are more valuable, because they’re paying more. And the probability of rates going down versus up is low. It’s possible we have negative yields across parts of the world, including parts of Europe. So it’s possible for interest rates to go down, kind of have to construct a narrative for it to happen.

Can they go down significantly? The answer is no. So it’s definitely asymmetric risk there. To your point, the only reason an investor should have bonds is to have a place to go in the time of crisis and there will be a time of crisis.

That’s the other thing that’s not normal about this year is the typical drawdown in the market is 14%. If we go back to no 1926, it’s 16%, meaning from top to bottom, somewhere in the year, the market goes down 14 to 16%. This year that hasn’t happened, nothing even remotely close. When that does happen, usually the bond part of a portfolio goes up, or at least maintains its value, giving someone a place to go in the event of a crisis. That’s really the way to look at bonds now. And really the way we’ve looked at bonds at Creative Planning from the beginning. We expect stocks to do better than bonds. We only own bonds as portfolio coverage over the short-to-intermediate run.

Jonathan: So yeah, you bring up the stock market and I think, for a lot of people, one of the big surprises of 2021 is how well the stock market has done following the surprisingly strong gains in 2020. In fact, as things stand, stocks have done better in 2021 than they did in 2020. It’s a reminder, at least to me, once again, that nobody can figure out where the stock market is headed in the short term. I mean, people who were bailing out of stocks at the end of last year are thinking that we’d had the best the stock market could deliver were clearly disappointed. They’re like sitting on the sidelines while the stock market roared ahead. Do you think that stock market investors are less antsy now, Peter, than they were a year ago? Or is there a lot of nervousness still in the market following the strong gains that we’ve seen in 2021?

Peter: What’s interesting, if you look at the consumer guidance, consumers seem to be very negative on the economic outlook, but they seem to be very bullish on the markets, which of course doesn’t make any sense. They tend to eventually move in tandem, although not perfectly. And I think where you see the most investor confidence is in the assets people should feel the least confident about. So the investors that seem to be the most confident are people that buy non-fungible token art, NFT art, things like that, where if we really do have of a severe correction, there will be a lot of blood in the streets and it’s going to start there. I think stock market investors, if you look at the stock market, the indexes have done really well, but there’s a lot of underlying weakness among a lot of individual stocks.

There are a lot of stocks that are far off their highs. And I think what the market showed again this year is, to your point, no one can predict it. Barron’s again, the top 10 forecasters, all wrong. Goldman Sachs, JP Morgan, Morgan Stanley all wrong about what the market’s going to do. You can’t figure it out. We talked about during the pandemic, a high expectation that this could be a V-shaped stock market recovery. That we described it kind of like a snowstorm, everyone went inside. And whenever it’s clear, everyone’s going to go outside. I mean, it was that plus a bunch of money dropped from the sky on people. It’s not surprising when you combine all that stimulus with a vaccine that has allowed people to go back out and do what they want to do. That combination, and you add in the advancement in technology, the adaptation of technology so quickly, in retrospect it doesn’t seem shocking. But, to your point, the stock market’s unpredictable.

One out of four years are going to be down, three out of four years are going to go up. And I think this is the key that people have a hard time with is it doesn’t matter if the stock market is relatively overvalued or relatively undervalued. That same three out of four odds of it being positive applies. The market could stay overvalued for extended periods of time, undervalued for extended periods of time. Or, as in this circumstance, a couple things could happen at once. You can have earnings accelerate quicker than people expected for reasons people didn’t expect and expected earnings to accelerate quicker than people expected, more stimulus to come in than people expected, and more adaptation to come in that people expected. The economy is very complex. There’s a lot of moving parts. Even the supply chain is very complex, as we’re learning, a lot of moving parts. So you can’t just look at one thing, say this is going to be this way, therefore the market’s going to go down. And this was just another perfect example of that.

Jonathan: Yeah. I mean, one of the things that we were reminded of this year is: One, the market really doesn’t care about current valuations. They care about what earnings are going to be, say 12 months from now. You go back to the beginning of 2021 and the price/earnings ratio on the S&P 500, if I recall correctly, was pretty close to 50, and we’re going to finish the year at half that. Earnings have recovered remarkably this year, and so valuations are starting to look more and more reasonable. And at the same time, another lesson from 2021, a lesson we learn every year is that the market is quick to discount what’s ever going on currently, and what drives the market is news. And we’re seeing this right now with this new variant. That’s what’s driving the market, not what happened to earnings in the second quarter, or the first quarter, or what the last inflation report was. That’s in the history books. The market is adjusted to that. It’s reflected in prices. Now it’s looking ahead. It’s looking at this new variant. It’s thinking about earnings in 2022, and that’s what will drive financial markets from here.

So of course, talking about unpredictable, Peter, we have had all the machinations in DC this year. People were bracing themselves for higher taxes and, well, they’re still bracing themselves for higher taxes. I know people were starting to play around with their portfolios, take gains, whatever, thinking that we were going to have higher taxes, and it hasn’t happened. Do you think we’re going to be left in limbo through 2022, or you think we’ll have a change in DC?

Peter: Well, taxes is something that’s really been surprising. At the beginning of the year, we were talking about getting rid of the break on real estate exchanges, getting rid of the step-up in basis on death, getting rid of having the 20% capital gains rate — move to the ordinary income tax rate for some people. Having estate taxes come in affected a much lower amount in terms of a threshold, but a much higher percentage of tax. All of that stuff appears to be completely out the window. Unless you make millions of dollars a year, you don’t expect now to see your taxes go up at all. And many people are going to get a tax break, and who knows if they’ll revisit it going into a midterm election or not. But for now, everyone can, for the most part, assume no last second surprise. And you just enjoy the holiday season and not worry about having to do all kinds of crazy planning at the last second.

Jonathan: So just like you can’t guess the short-term direction of the interest rates, you can’t guess the short-term direction of stock prices, you can’t guess the short-term direction of politicians. That’s the lesson of 2021. So, any other lessons from the past 12 months, Peter?

Peter: Well, I think that there’s so much stuff that happens. So, I think there is a lesson that is to be learned from 2021. So, when they write this in books five years from now, they’re going to look back on this period and talk about the importance of earnings. If you look at some of the things that went way, way up, stocks based on memes, right? So stocks just based on people talking up a stock online, even though the stocks make no money and have no path to make money. When you look at people buying NFT art, I think their NFT art will have value just like real world art has value, but most of it will prove to be worthless. Cryptocurrencies, there’s now 6,000 plus of them. 99% of them will prove to be worthless. And right now there’s this “I can’t lose” feeling.

“This is the future and therefore, if I invest in this, it will go up. And the proof of that is it’s been going up for the last several years, especially this year, and more and more people are adapting these things. So I’m on the cutting edge and it’s going to work out.” Not true. What’s going to happen is just like with the dot-com bubble. The internet was real, but that does not mean everything associated with the internet is a good investment. So yes, some cryptocurrencies are going to work out. Yes, some NFTs will be worth something, but your magical horse is probably going to be worthless. That piece of art you bought, probably going to be worthless. And I think we’re going to see this fall out. And a lot of people are going to get hurt when this happens.

And I think there’s not a lot of journalistic courage here. There’s a lot of really popular writers like at The Wall Street Journal and other places that don’t really say any of this with conviction. And I’m going to be really looking forward to see what they say when there is blood in the streets. If you’re a consumer advocate, you’re in finance, this is the kind of thing you should be talking about. I think there’s going to be a lot of people that are going to lose a lot of money they can’t afford to lose. Will there be people that got the right NFT, the right cryptocurrency, make a fortune? Yes, there will be. Just as every internet company did not go under with the dot-com bubble. But there will be blood, right? It’s going to come. And I think that’s the lesson from 2021 that’s yet to be written.

Jonathan: Well, I’ll just in defense of ink-stained wretches, let me say this, Peter. I mean, one of the things that goes on if you’re a journalist is you get bullied just like everyday investors do by what happens in the market. So, if you have something like NFTs that defy gravity, if something like cryptocurrencies that defy gravity, meme stocks that defy gravity, even growth stocks that do tremendously well, despite hugely rich valuations, eventually you don’t say this is going to end in tears because you’ve said it three times before and you’ve looked foolish. And after a while, people don’t want to look foolish anymore. If you bang that same drum week after week, month after month, well, you’re probably going to end up getting a new job.

Peter: Yeah, I understand. It’s a long game though. And I think there will be books written about it. It’ll be interesting to see the framing when that happens.

Jonathan: All right, Peter. So, the end of our podcast, our last podcast of 2021, what’s your tip of the month?

Peter: A lot of us make charitable gifts at the end of the year. 91% of our gifts are in cash even though over 91% of our assets are not cash. We should be giving away appreciated stocks to charities instead of cash. You not only get the same income tax deduction, but you get out of paying the capital gains tax on the sale of the stock. The charity can sell the stock and not pay the capital gains tax. Charity gets the same amount of money. You get a bigger tax break. The IRS gets a little less money. How about you, Jonathan?

Jonathan: So, on the theme of financial gifts, I was thinking about financial gifts that we tend to give to family at this time of year. Certainly I give financial gifts to my kids. A lot of people give gifts to their children, to their nieces and nephews. When you give those gifts, what I would say is you should tell your children or your nieces or nephews, why you’re making those gifts because, in telling them why you’re telling them what you think is important. If you feel that they need to take a vacation, then tell them to spend it on a vacation. If you think that they should be putting more into their retirement account or their college fund, or put it towards a house down payment, tell them that. When you give money, don’t just give money. Also, pass along your values. And you can do that by attaching a message to the financial gifts that you give.

So, that’s it for this month, Peter. This is Jonathan Clements, Director of Financial Education at Creative Planning. Speaking with me has been 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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