This Week in Review:

Inflation Fever Is Breaking




The patient hasn’t fully recovered, but it does appear that the fever has broken.

Polaris Investment Team | www.polariswealth.com

THIS WEEK:

Inflation slowed again in December as the consumer price index (CPI) clocked in at 6.5% year over year, down from 7.1% in November and well below the 9.1% pace registered last June. Led by lower prices at the gas pump, it was the sixth straight month that inflation eased. December’s 0.1% decline was the first monthly drop in consumer prices since a fractional decline in July.

While welcome, and in line with analysts’ expectations, it remains to be seen whether the news is enough to encourage Federal Reserve policymakers to relax their aggressive stance on future interest-rate increases. The Fed’s next two-day policy meeting begins on the last day of January. Given the recent inflation reading, we believe there is good justification for the Fed to raise interest rates by just 0.25% at that time.

Here are some of the other indicators we’re keeping a close eye on and why:

  • We’re watching the housing market slump as a potential harbinger of lower inflation. Rents, a key component of inflation, are in decline as well. Typically, rents rise about 3% each year; they fell at a 3% annual pace in the last three months of 2022. While this trend is certainly welcome for tenants, it could prove problematic for real estate investors and multifamily construction firms as capital becomes harder to secure. 
  • A key component of pandemic-era inflation—used cars—is in freefall as borrowing costs rise and new vehicle shortages dissipate. Prices for used cars are expected to fall 4% this year—and that’s following a massive 15% annual decline in 2022. Still, it’ll take some time to get back to pre-pandemic prices after used vehicles soared nearly 90% from April 2020 to January 2022.
  • Jobs numbers for December landed in the “Goldilocks” zone—not too hot, not too cold. Employers signed on 223,000 new workers last month, the fewest in two years but enough to push the headline unemployment rate down to 3.5%. The real excitement on Wall Street came from wage data, which showed salary increases are slowing, providing some relief from the cycle of higher paychecks leading to increased spending, which then leads to higher inflation, which in turn leads to demands for higher wages. 

Chart of the Week: Looking for Signs of the Bull

2022 certainly proved to be a dour environment for investors. By year-end the S&P 500 index was down 18.1% (and that’s including dividends). Unfortunately, the pain was not relegated to stock investors, as the Bloomberg U.S. Aggregate Bond Total Return index was also down more than 13%. This made for an exceedingly difficult landscape. 

For 35 years, the American Association of Individual Investors has been publishing its AAII Sentiment Survey, offering insight into the opinions of individual investors by asking them their thoughts on where the market is headed. Since AAII began collecting this data, the number of respondents with a bullish sentiment has averaged 37.6%. 

In 2022, for the first time in the history of the survey, there was not a single week when bullish sentiment readings came in above the historical average. Even for long-standing, well-diversified investors with decades of experience, last year felt terrible.

Number of Weeks With Above Average Bullish Sentiment in AAII Survey
Source: Bespoke Investment Group.

And that gives me confidence. I’ve been managing money for nearly two decades, and it’s been my experience that when investors feel the worst is often the best time to be invested. When sentiment is at a high, forward-looking returns are significantly below average; conversely, when sentiment is at extreme lows, returns are among the very best.

The state of the sentiment indicator isn’t the only reason to have some hope for a bounce back in 2023. Since it was launched in 1957, there have been 17 previous calendar years where the S&P 500 posted a loss. Not only did the index make gains in all but three of the following years, but the average return was 12% (or 19% if you look at the median return). And that’s not counting reinvested dividends. It’s not a guarantee, but bad years in the market are typically followed by good years.

2022 marked a year of performance extremes for nearly every asset class. Outside of commodities and the U.S. dollar, virtually all of them suffered significant losses. The fact that bullish sentiment came in at its lowest levels ever for a full calendar year stands as a testament to the lack of confidence prevalent among investors today. But it also may portend an otherwise unforeseen rally right around the corner. Stay tuned!

A New Year for Bonds?

Bad Years Are Often Followed By Good Years
Note: Chart shows calendar years when the S&P 500 index declined in price and the performance of the index the following year from 1958 through 2022. Sources: S&P Global, Adviser

Senior Vice President, Fixed Income Manager Chris Keith:

When it comes to bonds, the best thing I can say about 2022 is that it’s over!

After years of low, low interest rates, the days of reckoning came in 2022. At first the pain was minimal. The Fed took one small step with a single interest-rate hike of “just” 25 basis points (or 0.25%) in March. Then the onslaught—four consecutive rate hikes of 75 basis points each, bookended by a pair of 50-basis-point actions. All told, there were seven rate hikes in 2022, raising the fed funds rate by 425 basis points, throwing bond prices for a loop.

When all was said and done, the U.S. bond market (as measured by the Bloomberg U.S. Aggregate Bond index) had its worst calendar year on record in 2022, dropping 13%.

The catalyst is no surprise: After initially suggesting that higher consumer prices were transient coming out of the pandemic, the highest level of inflation since the early 1980s called for decisive action from the Fed in 2022. Debating whether Chairman Powell & Co. should have acted sooner or done something different isn’t going to change the outcome for fixed-income investors. The next logical question: Where do we go from here?

My team and I believe the new year will create a better environment for bond investors. Among the reasons for our optimism:

  • Inflation is moderating
  • The Fed’s interest-rate hikes are slowing
  • High-quality bonds offer more yield (read, income) today than they have in well over a decade
  • After years of accepting return-free risk, bond investors once again can buy a low-risk government-backed bond (Treasury) that earns an acceptable rate of return

In my latest blog post, I look at each of these topics in turn. Click here to read more!

Keys to Long-Term Care Coverage

One important New Year’s resolution is to make sure you have appropriately sized insurance coverage, including life, disability and property/casualty policies. And there’s an additional policy that is often overlooked—long-term care. 

While expensive, long-term care insurance can help protect you, your family and your financial legacy from debt related to your future care. If you decide it’s worth considering, here are a few of the key policy provisions.

Your daily or monthly benefit. This outlines how much the insurance company will pay based on your policy. But what’s the right amount of coverage? A private room in a nursing facility can cost over $100,000 per year, while assisted living comes in at $50,000 annually. One rule of thumb: If a policy pays less than $50,000 per year, you may want to bump up your coverage.

The benefit period. This is the amount of time a long-term care policy will provide coverage. A typical stay in a nursing home is about three years for a man and four years for a woman. Therefore, you will want to have a benefit period that is at least that long. 

Payout option. Long-term care benefits can be paid in a few different ways. One payout option is indemnity. In this case, the insurance company pays you an agreed-upon daily or monthly benefit—regardless of your actual long-term care expenses. (You might even receive more from the policy than the actual cost of care.) The second payout option is reimbursement, where you provide receipts to the insurance company and they reimburse you for expenses incurred. Keep in mind that the indemnity option is usually much more expensive. 

The elimination period. This determines how long you must wait for policy benefits to begin. Waiting too long may mean you pay much more out-of-pocket before policy benefits kick in, so try to keep the elimination period to 90 days or less. 

Inflation rider. Private nursing home costs have risen about 66% over the last 18 years and costs of assisted living facilities are up 88% over the same period. If you purchase a policy when you are young (say, in your early 60s), make sure your benefits include inflation protection.

There are a host of nuances to long-term care coverage. We’re here to help you figure out what’s right for your family’s specific situation. Call us today!

Looking Ahead

Markets, Polaris and Adviser will be closed Monday in observance of Martin Luther King Jr. Day. Next week, we’ll be looking closely at fresh data on manufacturing, retail sales, homebuilding, housing starts, sales of previously owned homes and the Federal Reserve’s “Beige Book” of anecdotal reports on businesses and the economy nationwide.

As always, please visit www.polariswealth.com for our timely and ongoing wealth management commentary. In the meantime, all of us at Polaris Wealth wish you a safe, sound and prosperous future, and a bright new year.

If you’d like to learn more about our tactical or fundamental strategies, please contact our team at 800-268-9046 or info@polariswealth.com.

Please note: This update was prepared on Friday, January 13, 2022, prior to the market’s close.

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