This Week in Review:
Does Wall Street Believe in a 'Santa Claus Rally'?
Consumer confidence jumped to an eight-month high on Wednesday, reflecting easing inflation concerns and relative optimism about jobs. Expectation-topping quarterly results from Nike and FedEx also boosted traders’ confidence. The S&P 500 gained 1.5% and all 11 sectors of the broad index finished the day in the green.
But Wednesday’s mini holiday rally couldn’t erase what’s been another tough stretch for traders and investors. The S&P is down nearly 6% so far in December, and the tech-heavy NASDAQ Composite is off just about 9% for the month as we write this.
Throughout this year’s trying market conditions, our commitment to ensuring you reach your long-term financial goals has never wavered. We are as grateful as ever for the trust you’ve placed in us, and we wish you a very merry week.
Here’s what else we’re watching as we celebrate the holiday season:
- Whether the overall economy is heading for recession is up for debate. But when it comes to the housing market, there’s little doubt it’s in a funk: Previously owned home sales fell nearly 8% in November from the month before—the 10th straight monthly decline. Sales were off a whopping 35% from the same time last year. Higher mortgage rates have crippled residential construction, with single-family homebuilding falling to a two-and-a-half-year low in November.
- The trucking industry—which transports 72% of freight in the country—has been hard hit by the home construction slowdown. With builders requiring less material, there’s less of a need to move materials around the country. Higher diesel prices have also hurt.
- American farmers have a lot to celebrate this holiday season, with inflation-adjusted income at the highest level since 1973. Russia’s invasion of Ukraine and weather challenges in other growing areas have resulted in higher prices, benefiting producers of crops and livestock and allowing them to spend more on seed, fertilizer and capital improvements (tractors, combines, planters and the like).
- SECURE Act 2.0 is up for a vote in Congress this week as part of an end-of-year spending bill (the Senate passed a version yesterday, now it’s on to the House). We’ll be paying close attention to the bill’s progress and will share our perspective on the provisions that could impact you if it’s signed into law.
Chart of the Week: Is the Market Overvalued?
The final weeks of December are Wall Street pundits’ favorite time of year. Why? They get to issue all sorts of bold predictions about what the market will do next year. If they’re right, they’ll be sure to crow about it come next December. And if they’re wrong, they can be nearly as certain that their off-base calls will be buried among a pile of other bad bets. Current forecasts for 2023 range from extremely bearish to overly bullish—clearly, they can’t all be on target.
There is one thing Wall Street analysts do seem to agree on: The S&P 500’s valuations are above historical norms. Call us cheeky, but we think they might be wrong about that, too.
Our chart of the week shows the forward price-to-earnings ratio (P/E) for the S&P 500, that is, what Wall Street projects the firms in the S&P 500 will earn over the next 12 months vs. their stock price. Currently, the forward P/E stands at 16.87. And we must admit, that’s above its 20-year historical average of 15.45.
But as we discussed last week, the biggest firms in the S&P can have an outsize impact on the overall index. By themselves, Apple, Amazon and Microsoft account for over 14% of the index, meaning the remaining 497 firms account for the rest. All three of these companies carry valuations much higher than the rest of the market: $840 billion for Amazon, $1.75 trillion for Microsoft and over $2 trillion for Apple. Their inclusion skews the price-to-earnings reading, in our opinion.
We suggest instead looking at the S&P 500 Equal Weight Index for a clearer picture. This index gives all 500 companies the same weighting and an equal influence on valuations. The forward P/E ratio of the equal-weighted S&P 500 is 14.35—a number well below the index’s 20-year average. Some might even call this…undervalued!
So, what’s the takeaway? The largest stocks in the index may have more pain on the horizon, but we believe pockets of this market are already properly valued and reflect current economic conditions. In this stock picker’s market our team continues to believe it’s possible to find both stability and risk-adjusted returns to reduce volatility in your portfolio in 2023.
Note: Chart compares forward P/E for the SPDR S&P 500 ETF Trust and the Invesco S&P 500 Equal Weight ETF from 12/31/16 through 12/20/22. Sources: FactSet, Polaris Wealth
Déjà Vu All Over Again for Yields
Cash has been king this year, and money market yields sure are looking tempting this month. But be aware that the spike in tax-exempt (aka municipal) money market yields is likely to prove fleeting.
Vanguard Municipal Money Market fund’s yield has more than doubled in December—rising from 1.70% to 3.46% (as of Tuesday). Meanwhile the yield on Vanguard Cash Reserves Federal Money Market has only increased from 3.72% to 4.13% over the same period.
How do we explain that massive upturn in the tax-exempt money market fund’s yield? (And note that these changes in yields are not limited to Vanguard funds; they are found across the industry. I’m just using Vanguard’s funds as a proxy here.)
We can attribute part of the move higher in money market yields to the Federal Reserve hiking the fed funds rate in the middle of the month. But that’s not the whole story—otherwise the taxable money market’s yield would have moved dramatically higher too.
And even if the Fed has put its finger on the scale in 2022, this municipal money market yield bounce is a pattern we’ve observed in years past. Tax-exempt money market yields spike higher in December only to reverse course in January (below, see the second chart showing what happened in late 2019 and early 2020—the last time yields were significantly above zero).
This seasonal rise and fall in yields reflects the actions of both individual investors and institutions.
Regular investors sell money market funds to cover holiday bills. Institutional investors engage in year-end “window dressing” (temporarily altering their portfolio to show a specific outcome, e.g., a higher absolute yield), shifting from lower-yielding municipal money market funds to higher-yielding taxable bond funds. In January, when individuals and institutions revert to their normal activities, money market yields correct.
So, if you own a tax-exempt money market fund, enjoy those higher yields while you can. Like all good holiday deals, they won’t last forever.
Note: Chart shows daily SEC yield levels for the Vanguard funds listed from 12/1/22 through 12/19/22. Source: The Vanguard Group.
Note: Chart shows daily SEC yield levels for the Vanguard funds listed from 12/2/19 through 1/31/20. Source: The Vanguard Group.
And shipping costs are coming down as the backlog clears. The Shanghai Containerized Freight Index, a gauge of shipping prices out of China, is at one-third its June level. The average price for shipping a 40-foot container fell to its lowest level in two years earlier this month.
Backlog cleared. Supply chain becoming unkinked. That translates into lower inflation—and should continue in the months and quarters ahead. Of course, you won’t see that in the headlines…because bad news sells.
Keeping Real Estate in the Family
A qualified personal residence trust (QPRT) is an irrevocable trust that allows you to pass a home to the next generation in a tax-friendly manner during your lifetime.
Often, you’ll see a QPRT used for a high-value vacation property. Imagine you own a lake house, for instance. You’d like to keep it in the family, but you’d also like to minimize the recipient’s (and your own) exposure to estate or gift tax.
That’s where a QPRT comes in: The property is transferred to an irrevocable trust during the grantor’s lifetime. They can remain in the home for a specified period of time, after which the residence becomes the property of the trust beneficiaries. The savings occurs because a QPRT “freezes” the value of the property at the time when the trust is created, thus removing the future growth of the property from the grantor’s estate.
Frequently, a QPRT is paired with an intentionally defective grantor trust (IDGT), which is a tax strategy that makes the grantor, not the trust, responsible for paying income tax on an asset. Both tax strategies are even more handy when you consider that the current federal estate-tax exclusion of $12.06 million is set to expire on the last day of 2025—after that, the exemption could slide down to about half of that amount.
QPRTs and IDGTs are extremely complex, with many more steps and stipulations than we can mention here. Before implementing either, speak with your wealth adviser to make sure the strategy suits your needs and to plan next steps.
Markets and Polaris Wealth’s offices will be closed Monday in observance of the Christmas holiday. When we’re back at our desks Tuesday morning, we’ll be at your service while looking closely at next week’s fresh data on housing prices, manufacturing and jobless claims.
In the meantime, all of us at Polaris wish you a safe, sound and prosperous future, a happy Hanukkah, a merry Christmas and a joyful Kwanzaa. To all of you who are traveling or may otherwise be impacted by the winter storm sweeping the country, we hope any disruptions to your holiday celebrations are easily overcome.
If you’d like to learn more about our tactical or fundamental strategies, please contact our team at 800-268-9046 or email@example.com.
Please note: This update was prepared on Friday, December 23, 2022, prior to the market’s close.
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