This Week in Review:

Has the Inflation Tide Turned?

Inflation concern went wild on Wall Street again this week as traders grappled with widespread protests in China over draconian COVID-19 lockdowns and the potential disruption to China’s exports of, well, everything.

Polaris Investment Team | www.polariswealth.com

THIS WEEK:

Positive developments on the inflation front sparked a global rally for stocks early this week. Then Federal Reserve Chair Jerome Powell had his say and the party ended.

On Tuesday, the latest consumer price index report showed core inflation, which excludes volatile food and energy prices, inched up 0.2% in November from the previous month—the smallest advance since August 2021. While prices for goods and services have climbed more than 7% from a year ago, signs that peak inflation may be behind us fueled hopes that policymakers would enact a less aggressive stance at this week’s central bank meeting.

And that’s what they did, meeting expectations and raising interest rates by 0.50% rather than 0.75%, putting the federal funds rate in the 4.25%–4.50% range.

So, what spooked the markets? The Fed raised its estimates for where interest rates will need to climb to truly tame inflation. In September, the central bank estimated rates would top out at 4.6%. It now envisions rates hitting 5.1% by the end of 2023.

“We welcome these better inflation reports,” Powell said in yesterday’s press conference. But despite positive trends in prices of goods and housing, “the big story will really be the rest of it. And there’s not much progress there—and that’s going to take some time.”

Whether you consider the Fed’s perspective a glass half full or half empty, we see many positives about prices as we head into 2023:

Here’s what else we’re watching this week and why:

The price of gas has fallen noticeably. In June the average cost to fill a 16-gallon tank was $80. Today it’s $52, a 35% reduction. (We have more to say about the trend below.)
The dollar’s strength has made it more affordable for Americans to buy goods from abroad. (Even with the recent pullback, the dollar is still up about 8% this year.) The cost of imports retreated for a fifth consecutive month in November, helping to ease U.S. inflation.
Prices are also falling for wholesale goods, another promising sign for consumers. The producer price index—a measure of prices received by manufacturers for their wares—clocked in at 7.4% year-over-year last month, down from 8.1% in October.

Chart of the Week: Legends of the Fall

By Matthew P. Erickson, Senior Portfolio Manager

Not only has 2022 presented investors with one of the most challenging bear markets of my nearly 20-year career, but it may also mark the end of an era for a handful of mega-cap companies responsible for the majority of the S&P 500’s returns over the past several years.

The so-called FAANG stocks—Facebook, Amazon, Apple, Netflix and Google—have been the five largest stocks in the S&P 500 in recent years. During the five-year period from 2017 to 2021, an equal-weighted basket of the FAANGs returned more than 36% per year on average.

Returns for the average stock in the S&P 500 during those years? 16%.

Sources: Polaris, Morningstar

At their peak, the five FAANGs accounted for more than 30% of the S&P 500. Simply put, had you not owned those stocks, keeping up with the returns of the S&P 500 would have been nearly impossible.

When we see extremes in the stock market, a reversion to the mean should be expected. Few investors anticipated just how strong that reversion would be. Coming into this year, the FAANG stocks were some of the most common holdings in both individual and institutional investors’ portfolios. While the S&P 500 is currently down around 16% year-to-date and the NASDAQ 100 is hovering around losses of 30%, the FAANG stocks are now down more than 45%.

Sources: Bloomberg, Polaris.

A quick glance at the chart above shows why 2022 has been so difficult for most investors.

It’s a bitter lesson, but a valuable one. Dominant market leaders in one era almost never maintain leadership in the next one. Growth at Meta and Netflix has already slowed, while the massive size of Amazon, Apple and Alphabet make it that much more difficult for them to be nimble and adapt to a changing landscape.

I don’t think the pressure on the FAANGs and other mega-cap growth stocks will let up. Value stocks have considerably outperformed in 2022, something they have not done with any measure of consistency for more than a decade. From where I sit, I believe investors would be wise to position themselves for a continuing trend.

Note: Facebook was renamed Meta Platforms in 2021. Google was renamed Alphabet in 2015.

Gas Prices Shake Off Ukraine Shock

When Russia invaded Ukraine, oil prices rose as high as $120 per barrel. Gasoline prices followed suit. And when the cost to fuel up rises as fast as it did earlier this year, it’s impossible not to notice. Heck, prices were posted in giant fonts all over town.

But while the media eagerly announces the climbing cost of living in headlines, how about when prices are falling? It may surprise you to see that U.S. gasoline prices, on average, have returned to levels we saw before Russia invaded Ukraine.

Note: Chart shows weekly U.S. regular conventional retail gasoline prices (dollars per gallon) from 12/31/21 through 12/12/22. Source: Energy Information Administration.

Inflation has been a pain point all year long—for consumers and investors. At least when it comes to filling up the tank, higher prices are a thing of the past.

The 'SLAT' Advantage—Spousal Lifetime Access Trusts

A spousal lifetime access trust (SLAT) can be an incredibly powerful estate planning tool for high-net-worth couples and families.

What’s the concept? Simply, it’s when one spouse (or both) creates a trust, with the other as the beneficiary. At a high level, a SLAT removes assets from one’s estate while still allowing access to those assets and providing protection from creditors. A SLAT also locks in the current estate-tax exemption.

That last bit is icing on the cake: You may recall that the federal estate-tax exclusion was increased to a whopping $12.06 million in 2017 thanks to the Tax Cuts and Jobs Act. And the number is double for married couples. (You will also see this figure referred to as the “unified credit”—the lifetime dollar amount one can gift or pass to the next generation before triggering gift or estate tax.)

That $12.06 million figure is important because the increase is scheduled to sunset after 2025—reverting to $5.49 million (which will be adjusted for inflation)—unless Congress decides to make the higher exemption permanent.

We don’t have a crystal ball, so we don’t know if legislators will act. But we do know that locking in the higher exemption now, rather than waiting to see how it pans out, is an idea worth considering. Here’s what it looks like at a very high level:

You create a $12 million SLAT with your spouse as beneficiary
Your spouse creates a similar trust with you as the beneficiary
In effect, you’ve moved $24 million in assets outside of your estate, safeguarding the higher exemption before it possibly reverts down in 2026

SLATs come with some limitations. For instance, upon the non-donor spouse’s death or in the event of a divorce, the donor no longer has the same indirect access to the trust assets. And if each spouse creates a SLAT to benefit the other, careful planning must be done to avoid the “reciprocal trust doctrine” (when the IRS interprets the two trusts as constructively similar or interrelated).

Work with your wealth adviser and tax strategist before implementing a SLAT to make sure it meets your needs and is being drafted and executed properly.

Looking Ahead

Next week, we’ll be examining fresh data on homebuilding, consumer confidence, existing home sales, GDP, leading economic indicators, inflation, durable goods, disposable income and spending, and new home sales.

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, December 16, 2022, prior to the market’s close.

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