To My Clients, Friends & Observers:
The S&P 500 Index declined -19.64% on a price basis and -18.32% on a total return basis in 2022. It has only been down 2 years in a row 4 times: the Great Depression; World War 2; the 1970’s Oil Crisis; and the dot-com bubble from 2000 to 2002 (a 3 year decline). We are in the third year of the 4-year presidential election cycle, which historically has been the best performing. And while we experienced a shallow recession in the first half of 2022, the nearly total consensus is for another recession in 2023, the degree of which is uncertain.
Leading economic indicators were 29 through November; coincident indicators were 67; lagging indicators were 83. Numbers greater than 50 are positive; lower than 50 are negative. To explain the terms, new orders (sales) would be a leading indicator, actual production would be a coincident indicator, finished goods inventories would be a lagging indicator. What leads indicates what follows. A slowdown (“soft landing”) or shrinkage (recession) in Gross Domestic Product is indicated. Recessions do not doom stock markets. Markets most often bottom before a recession starts and begin recovery during. The S&P peaked over 4600 in April 2022 and trades at 4000 now. Much of this pessimism is priced into the market. Jamie Dimon, the CEO of JP Morgan Chase, stated in December that the consumer has approximately $1.5 trillion in available funds which will be exhausted by June, after which to expect a recession. Big selloffs don’t occur in this atmosphere, they occur during periods of rampant, euphoric bullishness. I am getting more optimistic.
Inflation is contained by two ways: raising interest rates above the inflation rate and by curtailing the growth of the money supply. The Federal Reserve is slowing the economy by raising interest rates, making capitalization more expensive, including mortgage rates which subdue housing construction and sales. This eventually hits corporate earnings. They were robust in the 4th quarter – over 12% for the S&P- but they are slowing in 2023. See the big layoff announcements from Microsoft, 3M, Google and others. Layoffs are good news for stocks. And while the Fed remains committed to rate increases, determined to check inflation, expect smaller rate increases ending sometime this year. It took 5 years of rate increases to kill the inflation in the 1980’s. Inflation has slowed to a 6.1% year-over-year rate most recently. But the month-over-month rate of increase is practically zero and the reason for this is that the money supply (M2) has actually been shrinking since May 2022. While both inflation and deflation are detrimental to financial investments, disinflation (decreasing inflation) is quite positive. A best-case scenario for the markets would be a shallow recession and a return to positive real interest rates.
While getting through the cycle is tedious but inevitable, we are stuck with a hangover caused by a spendaholic Congress of a Leviathan administration, increasingly dominated by unelected administrators, regulators and public sector unions most of whom share a homogenous, self-serving ideology (“root causes”). The latest $1.7 trillion annual budget is in every sense of the word incomprehensible. The federal debt owed by the public is over $100 trillion. This would take centuries to repay for a healthy, growing economy. In fact, it can never be repaid. There will be a reckoning. I’ve often said that I am less concerned with market cycles and investing in good corporations than I am about the whole system disintegrating.
Republicans like to cut taxes and spend. Democrats like to raise taxes and spend. Taxes are the result of spending. Mitigate the spending and you mitigate the taxes. The debt is unmanageable. A letter to the Wall Street Journal recently was exceptionally pithy: “A social welfare state with open borders – what could possibly go wrong?” Look to Argentina, a social welfare state with open borders. Everyone, with the exception of its political and government types, is uniformly poor. Of course, when the people are uniformly poor, they don’t realize how poor they are – a principle keenly understood by their masters. The principal fiscal difference between Argentina (from the Latin word “argentum,” meaning silver or money) and America is the U.S. ability to pay its obligations by printing dollars, the globally accepted reserve currency.
What has enabled the fairy tale of Modern Monetary Theory is this exploitation of the dollar as the principal world reserve currency. It enables the Federal government to print currency to satisfy its current obligations without a concurrent devaluation. The currency is backed with debt, which interest payments are already crowding out other essential expenditures for entitlements, Social Security, Medicare, and the national defense. The dollar will remain the standard for global transactions for the foreseeable future but there are alternatives aborning. The Chinese and Russians have made barter agreements to exchange goods and raw materials without any dollar insinuation. India is exploring the same. Brazil and Argentina have agreed to a hybrid currency as an alternative to the dollar. Increasingly, funds and private investments are being denominated in yuan instead of dollars or local currencies. De-globalization continues apace, regrettably, in my opinion.
Traditional IRA’s are generally funded with tax-deductible contributions that grow tax-deferred until withdrawals begin, which are then taxed as regular income. Roth IRA’s are funded with after-tax contributions that grow without further taxation, including withdrawals which are tax free. That is the key difference between the two.
A new book by Ed Slott, CPA, titled The New Retirement Savings Time Bomb (Penguin Books, $18) makes some convincing arguments for considering a Roth IRA, either by conversion from a traditional IRA or establishment of a new contributory Roth IRA. They deserve serious scrutiny if you have tax concerns for you or your beneficiaries now or in the future. The rules are complex so Roths should only be considered with the help of a qualified tax advisor, which I am not. Discuss with your CPA. The personal tax reductions of the Tax Cuts and Jobs Act of 2017 are due to expire in 2025. It is said that the Tax Code is written in pencil because it changes so frequently.
When I moved my residence two years ago, I gave away 16 cartons of books. It was hard to do. One of my children asked me once, “Dad, if you’ve already read these books, why do you keep them?” Because, I explained, they are friends. They are always there for me. I can always go back to them and be welcome. They are full of ideas. They entertain me. They teach. They make me think. They share with me places and times otherwise unknown to me. They argue without anger or threats.
One of the books I kept is Lying: Moral Choice In Public And Private Life by Sissela Bok (Pantheon Books, New York, 1978), a professor of medical ethics at Harvard Medical School. It is a deeply researched, thorough examination of lying, in philosophy and in practice. What are truthfulness, deceit and trust? What are the consequences of lying? When are lies justified, excusable, necessary, and even beneficial? When are they not and how grave is the harm?
Written when the Watergate break-in and subsequent cover-up was still fresh in the national mind, she includes a chapter discussing “lies for the public good,” citing Roosevelt, Johnson, and the Nixon administration. She acknowledges that government deception has always been and always will be. But political deception can’t be summarily accepted and dismissed. “The disparagement of inquiries into such practices has to be seen as the defense of unwarranted power – power bypassing the consent of the governed.” A government that feels free to deceive for some important public benefit easily succumbs to a “benevolent self-righteousness” which disguises the many motives for political lying which cannot be morally excused, i.e, the need to cover up, the vindictiveness, the desire to retain power. Political leaders accustomed to making such excuses become insensitive to fairness and veracity, leading to the conclusion that the public ultimately benefits from the lies by “keeping the right people in office.”
“Wherever lies to the public have become routine, then, very special safeguards should be required. The test of public justification of deceptive practices is more needed than ever. Those in government and other positions of trust should be held to the highest standards. Their lies are not ennobled by their positions; quite the contrary. Some lies may be more excusable than others, but only those deceptive practices which can be openly debated and consented to in advance are justifiable in a democracy.” (Page 181)
Lying has become endemic throughout government. The most mundane data is routinely manipulated. Everything is politicized. “Once public servants lose their bearings in this way, all the shabby deceits of Watergate – the fake telegrams, the erased tapes, the elaborate cover-ups, the bribing of witnesses to make them lie, the televised pleas for trust – become possible.” (Page 173) It’s beyond possibility now. It’s commonplace and corrosive. The more it is accepted the worse it gets. It can’t be countenanced.
According to the Bureau of Labor Statistics, payroll employment rose by 4.5 million in ’22, not the 10 million cited by the president. The 4.5 million was less than the 6.7 million in 2021. The “million jobs” created in January ’22 was restated to 10,000; the “1.1 million jobs created in the 2nd quarter 2022” was restated to a loss of over 300,000 jobs – both corrections made after the November election. Those employment statistics confirm what the negative GDP stats indicated in the first two quarters of ’22: the economy was in a recession, despite adamant denials and insinuations by our Treasury Secretary and other officials and pundits. Statistics reported by the administration are so routinely restated that they are no longer credible when released. It’s inexcusable. It’s endemic. This is data paid by, and for the benefit of, the public. The 2.9% annualized GDP reported for the 4th quarter will likely be restated. I have no inkling what it really was. I am an optimist by character and philosophy, but reckonings are inevitable.
Dennis M. O’Connor
PS: Investment themes I’m glad we avoided in ’22: blockchain, bitcoin, 5G.