Author: Albion Financial

Categories
Learn

Smart Money Moves: Tax Misconceptions

  

As we end another tax season, it’s crucial to address prevalent misconceptions surrounding taxes. Despite their annual familiarity, taxes remain a topic shrouded in confusion and misunderstanding. In this guide, we aim to shed light on some of the most pervasive myths and clarify the nuances of tax deductions, credits, penalties, refunds, and more. By debunking these misconceptions, we hope to empower readers with a clearer understanding of their tax obligations and opportunities for financial optimization.    

Tax Deductions  

There’s a common misconception that tax deductions automatically translate into a dollar-for-dollar reduction in taxes owed. This is not the case. While they do lower taxable income and can result in less taxes owed, tax savings thanks to deductions are based on your tax rate, unlike tax credits which offer a direct offset of taxes.   

Deduction Example:  

Last year, we aided a client in donating $20,000 worth of equipment to charity. Despite the substantial donation, the actual tax benefit depends on various factors, most significantly the client’s tax bracket. If the client’s income were to put them into the highest federal income tax bracket of 37%, the donation would lead to a total tax reduction of $7,400, not $20,000 ($20,000*0.37). A deductible expense simply means that you get a discount on the expense and are not required to pay income tax on the purchase.  

Tax Credits  

When it comes to tax credits, it is often understood that they’re interchangeable with tax deductions, which is not true. Tax credits directly reduce the amount of tax owed, dollar for dollar. Once your taxes have been calculated, any tax credits will subtract the total amount of taxes owed.  

Tax Credit Example:   

Take, for instance, the Child Tax Credit, which offers a $2,000 credit for a child 17 and under who is claimed as a dependent. If a single parent with a young child has a federal tax liability of $5,000, they could likely claim this credit thus reducing their tax liability to $3,000.  

Additionally, it’s important to note that tax credits aren’t necessarily free money. While they can be an added bonus, most credits only provide a refund if you owed taxes to begin with, meaning you earned enough in taxable income during the year to qualify for the credit, but not too much to no longer qualify. Understanding these distinctions is key to maximizing your tax benefits and avoiding misconceptions.  

  

Tax Deductions vs. Tax Credits  

Consider the comparison of tax deductions and tax credits in a shopping context. A tax deduction resembles a favorable promo code, providing a certain percentage off your total purchase—equivalent to your marginal tax rate (or the highest rate your income is taxed). Conversely, a tax credit operates akin to a gift card, offering a specific dollar amount reduction from your overall purchase. While not precisely free money, it’s a close second.    

Tax Penalties  

Another misconception exists around tax penalties, which are often believed to apply solely to those intentionally evading taxes. Tax penalties can stem from various factors, including underpayment, late filing, or inaccuracies on your tax return, regardless of intent.   

Tax Penalty Example:  

I received a letter a couple years back detailing an underpayment penalty on my tax return. The letter outlined that I owed more than what was listed on my tax return. Since it had been many months since filing my return, I was also being charged additional fees on the “late” amount because the additional taxes were due by April 15 (as federal taxes always are). Despite the stressful process, I enlisted the help of a CPA to appeal the penalty and avoided owing the additional taxes and penalties. If you end up owing more tax than originally paid, you will owe penalties on top of the underpayment amount for however long it takes for the IRS to notify you of the underpayment amount.    

Tax Refunds

Regarding tax refunds, many believe that refunds are free money from the government. It’s important to understand that a tax refund is not a gift from Uncle Sam, but rather signifies the return of your overpaid taxes throughout the year, though that doesn’t stop them from feeling oh so nice to receive.  

Tax Refund Example:  

If you owe $10,000 in federal taxes for 2023 and $9,000 was withheld from your paycheck for federal taxes throughout the year, you will owe $1,000 at tax time. Conversely, if $11,000 was withheld, you would receive a $1,000 refund. I spoke with a CPA friend recently who said that the only thing clients ever want is a refund, joking that he would be seen as a magician if he increased his clients’ paycheck withholdings for them to get massive refunds upon filing their tax returns. Many personal finance gurus have strong opinions for how to optimize withholdings. Find what works for you, just withhold enough that you don’t incur penalties.  

Business Write-Offs/Deductions

There’s a common misbelief that all business expenses are automatically deductible. Not all expenses qualify for deductions. Business expenses must meet the criteria of being regular, ordinary, and necessary for the operation of your business to be deductible, with certain limitations and rules in place.  

Business Deduction Example:  

An individual takes a business trip to a tropical destination, intending to deduct all associated expenses, such as hotel stays and meals. The IRS may deny such deductions if the trip is deemed primarily for personal enjoyment rather than business purposes. Make sure your business expenses qualify to be deducted prior to spending money you hope will be tax deductible.  

Gifting  

It is often believed that gifting will result in taxation for gifts exceeding the annual gift exclusion limit. While true in a way, it’s essential to understand that the tax-free exclusion amount—$17,000 for 2023 and $18,000 for 2024—applies on a per person basis. Also, individuals can give up to $13.61 million (2024 amount) in tax-free gifts in their lifetime (known as the lifetime gift exclusion), so this exclusion of $18,000 (for 2024) is the amount that can be gifted without counting against the lifetime exclusion. This can get very complex as there are varying gifting strategies to consider, and attempting to implement any of them on your own can be extremely difficult.  

Gifting Example:  

Consider an older couple aiming to provide generous gifts to their two married children without incurring taxes. In this situation, each spouse could gift $18,000 to both children and their spouses, totaling $72,000 in tax-free gifts per spouse or an impressive $144,000 collectively as a couple. All of this could be done without counting against the lifetime amount in tax-free gifts that can be given.   

529 to Roth Conversions  

A common misconception exists regarding education savings and deductions, particularly regarding the conversion of unused 529 balances to a Roth IRA (a new strategy from the Secure Act 2.0). While there is some truth to this notion, it’s crucial to understand the limitations involved.   

529 to Roth Example:  

Consider a scenario where you have $50,000 sitting in a 529 account but decide not to pursue further education. In such a case, you may contemplate rolling the funds into a Roth IRA, which could be an option. This maneuver comes with restrictions. For instance, the 529 account must have been open for at least 15 years, and the rollover cannot exceed the current year’s Roth contribution limits—$7,000 for 2024. There’s also a lifetime maximum of $35,000 per beneficiary for these rollovers. While there are more intricacies to be aware of, the process is not as straightforward as commonly believed.  

Tax Preparer Liability  

There’s a common belief that the liability for errors or inaccuracies associated with tax returns is solely on the tax preparer. It’s imperative to recognize that the individual, the taxpayer, is responsible for the accuracy of their tax returns, regardless of professional assistance.   

Tax Preparer Liability Example:  

If someone hires a CPA to file their tax return but provides inaccurate income information or doesn’t send all required information/supporting documents, they remain accountable for any discrepancies. In the event of an IRS audit uncovering errors, the individual is liable for rectifying the mistakes and covering any resulting back taxes and penalties.  

Conclusion:  

As we end tax season for tax year 2023, we extend our gratitude to the remarkable CPAs we collaborate with. As we at Albion Financial Group are not accountants and do not give tax advice, their expertise ensures accurate tax filing and reporting, guiding us away from the pitfalls of common misconceptions. To those dedicated CPAs tirelessly navigating the complexities of the tax code, we salute your unwavering commitment. Here’s to the invaluable knowledge they impart and the smooth tax planning ahead!   

Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.

Categories
Learn

Smart Money Moves: Paying Down Debt is Saving 

Introduction

In a financial landscape where interest rates on savings accounts are enticingly high, the decision between paying down debt or stashing cash becomes more intricate. This article aims to unravel a few of the complexities, arguing that even with the allure of a 5% interest rate in a High-Yield Savings Account, strategically paying down debt can often be a superior financial move. We will delve into the nuances of tax considerations and the importance of setting concrete financial goals to guide this decision-making process. 

The Emergency Fund

Prior to exploring better potential use-cases for idle cash, a proper emergency fund should be established. It is understood that the purpose of cash in an emergency fund is to provide financial security during uncertain times. For this reason, these funds need to be liquid, and as such, a High-Yield Savings Account is an adequate place to house this cash. 

The Temptation of High-Interest Savings

For funds above and beyond what is needed in an emergency fund, a 5% interest rate on a High-Yield Savings Account can be a tempting prospect, seemingly outpacing the interest paid on certain debts. However, the true impact of this nominal rate needs to be dissected, especially when considering the after-tax reality and the inherent trade-offs. 

Tax Considerations and the Reality of After-Tax Returns

One critical factor often overlooked is taxes. Interest earned in savings accounts is subject to ordinary income tax (the highest tax rates individuals can be subject to), which can significantly diminish the apparent superiority and allure of a 5% interest rate. The effective return, or after-tax return, will likely be much lower, potentially making the decision to pay down debt more appealing. 

Strategic Goal Setting

Rather than being swayed by high interest rates alone, individuals should set clear financial goals to guide their decisions. It comes down to determining a concrete purpose for every dollar in a financial plan. This could include saving for a home, funding education, or securing retirement. Defining a goal for each dollar allows for a clear answer as to how the funds should be used or invested. Rather than chasing the highest interest-bearing savings account in the short-term, it is necessary to shift to a long-term view. With a long-term focus and a goal for every dollar, the decision of what to do with additional funds becomes increasingly clear.

Paying Down Debt

A Closer Look at Mortgage Considerations: Take the example of a 3% mortgage on a home. While the nominal rate appears lower than the 5% savings interest rate, the tax implications must be considered. After accounting for ordinary income taxes (federal, state, and potentially net-investment income tax) on the interest earned in savings, the effective return may not be significantly higher, if at all (surprisingly, in the highest of personal income tax brackets, the calculation tips the scales in favor of paying down the debt in this scenario). In this light, paying down a low-interest mortgage, even in the current higher interest rate environment, can be a financially prudent move if there is alignment with the overall financial plan. 

Long-Term Debt as a Strategic Asset

Even when interest rates on savings appear attractive, individuals with long-term, low-interest debt, such as a mortgage, may find value in paying down this obligation. By strategically reducing debt, they enhance their financial flexibility and free up cash flow to use in pursuit of other goals. For this reason, paying down debt is saving. 

Conclusion

In the dynamic interplay between high-interest savings and debt repayment, strategic wisdom lies in the details. Nominal interest rates on savings accounts can be alluring, but after-tax considerations and the strategic goals one sets can redefine the narrative. As advocates for financial wisdom and well-being, we urge careful consideration of the overall impact on goals before deciding to invest or pay off debt. 

Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.

Additional information about Albion Financial Group is also available on the SEC’s website at www.adviserinfo.sec.gov under CRD number 105957. Albion Financial Group only transacts business in states where it is properly registered, notice filed or excluded or exempted from registration or notice filing requirements.

Follow this link for the PDF version of this article.
Categories
Events

Conference Call Recording – February 2024

Albion Financial Group – February 2024 Conference Call Video Recording

In our most recent conference call our panelists delved into the economic context of early 2024, touching upon various topics such as tax deadlines, interest rates, Artificial Intelligence, recession forecast, inflation and pricing trends, monetary policy, portfolio asset allocation, Secure 2.0 legislation, estate planning, and more!

Stream the audio of yesterday’s conference call at this link.

Categories
Learn

Monthly Market Recap – January 2024

Monthly Market Recap – January 2024 [PDF]Download

January 2024 Recap:

Inflation

Data released in January showed that as 2023 drew to a close, inflation was generally tame, but not quite tame enough for the Fed to declare victory. The Core PCE Deflator (the Fed’s preferred inflation metric) stood at +2.9% y/y as of the end of December, the first sub-3% print since March of 2021. Meanwhile, Core CPI printed at +3.9% y/y, also the lowest since the first half of 2021. While these figures are directionally encouraging, the pace of disinflation has slowed in recent months, and both metrics remain solidly above the Fed’s long term 2% target.

Monetary Policy

The main event for market participants in January was the FOMC meeting that concluded on Wednesday the 31st. While no one expected a change in overnight interest rates out of that meeting, everyone was interested in getting an answer to the question of “will they or won’t they” begin cutting rates at the March meeting. The answer, delivered as clearly as can be given the constraints of Fed-speak, is no. Jerome Powell made it very clear that the committee does not anticipate that economic conditions will justify the start of a rate cutting cycle in March.

Economy

Outside of the manufacturing sector, which mostly remains in contraction, economic data released in January was solid. Consumer confidence continues to climb, thanks in part to falling inflation that everyone can see at the gas pump. Lower mortgage rates stimulated activity in the housing sector. And the labor market remains strong: jobless claims are low (~200k initial claims per week), open jobs are plentiful (9 million per the most recent JOLTS report), and job creation continues to chug along (216k nonfarm payrolls added in the most recent monthly BLS job report).

Bond Market

The yield curve steepened in January, with 2y yields falling slightly while yields in the belly and (especially) the long end rising a bit. Longer term yields continue to be challenged by the outlook for US budget deficits, making them somewhat more attuned to the election cycle (and especially growing populist impulses across the political spectrum) that will unfold over the course of 2024. Most bond prices finished the month lower, although a contraction in credit spreads (to levels that are nearing historic tights) helped to cushion the downside in corporate bonds.

Stock Market

US large caps enjoyed a solid first month of 2024, but as was the case last year the gains were concentrated in a comparatively small number of individual stocks. Cyclicals and defensives were much more of a mixed bag, resulting in underperformance of small and midcap benchmarks that have greater exposure to such industries. International markets were mixed as well, with emerging market indices especially weak due to sharp underperformance in Chinese equities.

January 2024 S&P 500 Total Return by Sector

Albion’s “Four Pillars”:

Economy & Earnings

The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting approximately 10% EPS growth in 2024; growth of that magnitude will depend on the economy avoiding recession.

Valuation

The S&P 500’s forward P/E of 20x is above the long run average, so valuation could be a headwind to future returns. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Futures markets imply that the Fed will cut overnight interest rates several times in 2024, most like beginning mid-year. The belly and long end of the curve have already priced in a rate cutting cycle, with yields falling more than 100bp in the past few months.

Inflation

After reaching 40yr highs in mid-2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains somewhat elevated, in part due to heavily lagged shelter costs.

Albion’s Dashboard of Key Leading Economic Indicators as of 01/31/24
Categories
Learn

Crafting a Foundation for Lasting Income in Retirement 

“Consider it as sculpting a financial architecture…”

Embarking on the journey of retirement is akin to laying the foundation for a fresh chapter in your financial life, where the structure of your income becomes pivotal. In this exploration, we’ll delve into the art of income planning beyond retirement—a strategic composition not just to make your money last but to construct a financial foundation for a lifetime. Consider it as sculpting a financial architecture to support your lifestyle and aspirations. 

Understanding the Blueprint of Retirement Income: 

“The initial step is to decipher the blueprint of your income sources.”

In the realm of retirement income planning, the initial step is to decipher the blueprint of your income sources. Begin by evaluating and documenting your existing and potential retirement income streams, including pensions, Social Security benefits, and withdrawals from your investment portfolio. This exercise transforms your blueprint from an idea into a written account, outlining the contours of your retirement foundation. 

Key Considerations: 

  • Pensions and Social Security: Scrutinize the reliability and sustainability of these income sources, weighing factors like lump-sum versus annuity payout for pensions and potential changes in Social Security regulations or benefit age. 
  • Investment Portfolio: Consider how your investments will contribute to your retirement income. Evaluate the risk profile of your current portfolio and its role in shaping your overall financial structure. 

Building a Structure of Sustainable Income: 

“This exercise transforms your blueprint from an idea into a written account, outlining the contours of your retirement foundation.”

Once the blueprint is clear, the subsequent step is to construct a plan for sustainable income. During this phase, you are crafting a framework for your retirement income that not only covers your basic needs but also adapts to the dynamic nature of your financial landscape. 

Strategies to Consider: 

  • Systematic Withdrawals: Establish a plan for systematic withdrawals from your investment portfolio, ensuring a steady income flow. There are various withdrawal strategies worth considering; this one proves relatively easy to implement. 
  • Tax-Efficient Strategies: Explore tax-efficient methods to optimize your income. This may involve considering Roth conversions, strategic charitable giving, or other approaches to minimize tax implications. Remember that reducing your total lifetime tax payments holds more impact for your financial plan than merely reducing your current year tax liability. 

Fine-Tuning for Resilience: 

“During this phase, you are crafting a framework for your retirement income…”

Just as architects prioritize resilience in building design, your retirement income structure needs fine-tuning for resilience. Integrate risk management strategies to guard against unforeseen challenges and disruptions. The focus should be on the goals you’ve defined for your retirement, without succumbing to the uncertainties of the world around you. 

Resilience Strategies: 

  • Emergency Fund: Maintain an emergency fund to cover unexpected expenses and ensure a buffer against financial uncertainties. 
  • Insurance: Review insurance strategies to ensure alignment with your needs, providing a safety net for unexpected healthcare or other significant expenses you prefer not to bear. 

Adapting to Change: 

“Regularly reviewing and adjusting your plan ensures resilience against evolving personal goals and unforeseen events.”

Bestselling author Morgan Housel encapsulates the transformative nature of time with his statement, “World War II began on horseback in 1939 and ended with nuclear fission in 1945.” In the realm of retirement, where uncertainties abound, one undeniable certainty is change. Your retirement structure should be dynamic, embodying a key principle of financial planning—adaptability. Regularly reviewing and adjusting your plan ensures resilience against evolving personal goals and unforeseen events. 

Adaptability Strategies: 

  • Regular Reviews: Schedule periodic reviews to assess the effectiveness of your income plan and make adjustments as needed. 
  • Flexibility: Build flexibility into your plan to accommodate changes in lifestyle, healthcare needs, or financial goals. 

The Completed Project: 

“Be sure to carefully reflect on the structure you have built, ensuring proper alignment and cohesion with your aspirations and financial goals.”

As you conclude the process of crafting your foundation for lasting income in retirement, be sure to carefully reflect on the structure you have built, ensuring proper alignment and cohesion with your aspirations and financial goals. In this endeavor, you’re not only securing your own financial future but also building a legacy to endure for future generations. 

Just as a completed architectural project stands as a testament to the vision and skill of its creators, your retirement income structure becomes a tangible representation of your financial success. It’s a timeless blueprint, offering enduring stability to enrich your retirement journey and providing a solid foundation for the chapters that follow. As you navigate the complexities of retirement income planning, you’re not just securing your own well-being, you’re shaping a legacy that will resonate for years to come, ensuring that your financial story stands strong against the test of time. 

“You’re shaping a legacy that will resonate for years to come, ensuring that your financial story stands strong against the test of time.”

It is strongly advised to seek counsel from a qualified financial adviser, tax professional, or attorney before implementing any strategy or acting upon any recommendation outlined herein. Albion Financial Group disclaims any responsibility for the consequences of individuals’ decisions based on the information presented and encourages thorough consultation with a financial professional to ensure the appropriateness of any financial decisions made in consideration of personal circumstances and financial objectives.

Categories
Learn

Quarterly Letter Excerpt: Planners Corner

Happy New Year

The New Year is a good time to review your financial strategies to ensure they are aligned with your long-term goals – an expertise we bring to bear for our many client families. As the calendar turns and we look to the year ahead, what’s on your mind? What worries you? What excites you? Any hopes for the new year? As your wealth advisor, we endlessly ponder these questions. And while some items are more pleasant to contemplate, it can all feel daunting. We can’t know what the future will bring. But uncertainty is part of life, and each new year brings unexpected events that will impact who we are and how we think about the world.

Often, January is when we set goals for the coming year. But how when we can’t know exactly what’s ahead? Early 2020 threw us a global pandemic; 2021, a new US president; 2022 began with a Russian invasion of Ukraine: and in 2023 we jumped headlong into an artificial intelligence craze. Some developments are more consequential than others, but each brings unique
haziness. What might 2024 hold?

The good news is we don’t actually need to know, though we must be ready for anything. It’s in our nature to believe we can think on our feet and quickly adapt to a changing environment. Unfortunately, that’s easier said than done. For instance, consider a soccer player receiving the ball without having analyzed the whole field. Focusing solely on the ball forces them to react without proper scope. Should they pass, shoot, or perhaps execute a Maradona turn? Whatever the decision, they must act. Despite ardently training for this moment, full preparedness is lacking because they’ve neglected their surroundings. As it turns out, context and the bigger picture matters.

Just as situational awareness is necessary for athletic success, it also greatly impacts financial outcomes. Indeed, if you aren’t keenly aware of the backdrop (including self-awareness which takes into account our own behavior and biases) your abilities alone may not be enough when the “financial ball” is passed and critical decisions need to be made. As you’ve likely heard us say, we believe in the importance of quality advising where
financial success is the compounding result of a series of good decisions over time.

In soccer, it’s easy to know who wins – just look at who scored the most goals. Financial plans are different. What does it mean for you to win the “money game” you’re playing? Standard replies often center around the notion of financial independence, retirement, or a specific net worth. In fact, you could probably tell us precisely how much you’d like to make this year and what you’d like out of your investment portfolio(s), real estate, etc. Yet, viewing your finances in this way implies that money is a finite game with clear “winners” and “losers” bound by defined rules, limited resources, shared objectives, with cookie cutter endpoints and benchmarks. In truth, money and personal finance is an infinite game with no set finish line or buzzer. We must create individualized rules to offer our money utility. This personalization gives wealth purpose as we define both our goals and values. From there, we keep proactively “playing the game” based on this custom framework dedicated to your specific situation.

Bestselling finance author Morgan Housel has said the following about investing (one of the many areas of financial planning):

“It’s so easy to lump everyone into a category called
‘investors’ and view them as playing on the same field
called ‘markets’. But most of the time you’re just a
marathon runner yelling at a powerlifter. So much of what
we consider investing debates and disagreements are just
people playing different games and unintentionally
talking over each other. A big problem in investing is that
we treat it like it’s math where 2+2=4 for me and you and
everyone – there’s one right answer. But it’s something
closer to sports, where equally smart and talented people
do things completely differently depending on what game
they’re playing.”


Perhaps the single best game to impart the complexities of financial planning is three-dimensional chess with multiple opponents. Every move, every choice, creates additional uncertainties and interdependence that didn’t exist prior. And every move made by an opponent (e.g., externalities) creates the opportunity to reexamine one’s strategy. Financial plans can be continuously adjusted as each piece moves in the multi-dimensional chess game of life. Establishing an always monitored, ever evolving financial plan where we work together increases the odds of successful financial outcomes.

A central purpose of a financial plan is to help weather economic storms so that no matter what stage of life – accumulation, preservation, or distribution – you’re capable of absorbing and adapting to shifting environments. Let’s briefly revisit the notion of event-driven uncertainty. Think about the most recent significant global, national, or even local event. Did any of those catch you off guard, feeling unsure of your surroundings? Were you concerned about potential financial impacts? Going back to our soccer analogy, now imagine how would it feel to receive that “pass” amid the deafening stadium chaos, but this time you know exactly where you’re going. You’re prepared, situationally aware, and have filtered out the noise. Your coach’s (advisor’s) voice, the person with the best view of the entire playing field, comes through with great clarity and together optimal decisions are made.

Such arrangements bestow enhanced confidence to continue with the plan. When most are fearful, finding the signal in the noise provides us the refreshing opportunity to concentrate on other areas of life that truly bring joy and fulfillment. As your trusted wealth advisor, that’s the role we play. We’ll be here for you this year and beyond. Happy 2024!

Categories
Learn

Quarterly Market Recap – Q3 2023

Quarterly Market Recap – Q3 2023 [PDF]Download

Q3 Market Recap:

Inflation

The disinflationary trend mostly continued in Q3, although rising oil prices (+$20/barrel over 3 months) pushed headline inflation higher as the quarter progressed. The y/y change in Headline CPI rose 70bp between June and August to +3.7% currently, while Headline PCE rose 30bp over the same period and stands at +3.5%. Core (ex food and energy) inflation continues to moderate but remains higher, with Core CPI now at +4.3% y/y while Core PCE stands at +3.9%. Of note, consumers’ inflation expectations remain well anchored despite rising energy costs, with the U of M survey reporting 1y forward expectations of 3.2% while 5-10y expectations have fallen to 2.8%.

Monetary Policy

The Fed raised overnight interest rates by 25bp at its July meeting, to a range of 5.25% to 5.5%, and then did not change rates at the September meeting. The updated Summary of Economic Projections (SEP) implies one additional 25bp rate hike is still to come before year-end, but futures markets are currently pricing only a 50/50 chance of such an outcome. Sandwiched in between Q3’s two FOMC meetings was the Jackson Hole Economic Symposium, where Jerome Powell’s keynote speech once again made clear that the FOMC intends to keep its policy rate restrictive for some time to come, as summarized by the “higher for longer” narrative.

Economy

Q3 data was mixed. PMIs from S&P Global and ISM continue to show weakness or outright contraction in manufacturing, as do many regional Fed surveys. Consumer sentiment indicators from the Conference Board and the U. of Michigan have recently moved lower, a reversal of the upward trend from the spring and early summer. Housing markets continue to be plagued by availability and affordability challenges driven by high mortgage rates, hindering activity. Finally, the labor market is slowly normalizing, with wage gains slowing and the number of open jobs falling. Despite these cross-currents, consensus estimates among Wall Street economists for Q3 GDP Growth stand at +3.0% q/q annualized, while the Atlanta Fed’s real-time “GDPNow” estimate stands at a whopping +4.9%.

Bond Market

Rates moved significantly higher in the belly and long end of the curve in Q3, as excess refi supply of US Treasuries was met with weaker demand from key domestic and foreign buyers. Mortgage rates followed suit, and now sit well above 7% nationally for traditional 30-year fixed rate loans. Credit spreads were stable to slightly better in the quarter, pushing most of the price declines in Treasuries through to munis and corporates.

Stock Market

Equities rallied to YTD highs in July before succumbing to rates-driven pressure on P/E multiples in August and especially September. Energy stocks posted solid gains driven by rising oil prices, but otherwise the selling was broad-based across market caps, sectors, and geographies.

Q3 2023 S&P 500 Total Return by Sector

Albion’s “Four Pillars”:

Economy & Earnings

The US economy has shown resilience so far in 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in late 2023 / early 2024, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x is above the long run average, so valuation could be a headwind to future returns. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have drifted even higher in 2023 as the Fed remains firmly committed to fighting inflation. Futures markets now imply a roughly 50/50 chance of one additional 25bp rate hike before year-end, followed by a pause.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 18 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Categories
Learn

Elon Musk Biographer Speaks with Doug Wells About Latest Book

Elon Musk’s biographer Ashlee Vance was interviewed this week by Albion Partner Doug Wells on his KPCW radio program Mountain Money on the subject of Vance’s new book “When the Heavens Went on Sale”

Doug Wells interviews Ashlee Vance on KPCW’s ‘Mountain Money’

Ashlee Vance is an American business columnist and author, best known for his biography of Elon Musk, titled “Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future” which was released in 2015.

The biography traces Musk’s journey from his difficult upbringing in South Africa to his ascent to the pinnacle of the global business world. The book provides an outline of the experiences that have made Musk the man he is today, and how he has always dreamed big.

Vance’s new book called “When the Heavens Went on Sale: The Misfits and Geniuses Racing to Put Space Within Reach” tells the remarkable, unfolding story of a frenzied low Earth orbit “land grab.”

Through his trademark immersive reporting, Vance follows four pioneering companies—Astra, Firefly, Planet Labs, and Rocket Lab—as they build new space systems and attempt to launch rockets and satellites into orbit by the thousands.

While the public fixated on the space tourism being driven by Elon Musk, Jeff Bezos, and Richard Branson, these new companies arrived with a different set of goals: to make rocket and satellite launches fast and cheap, thereby opening Earth’s lower orbit for business—and setting it up as the next playing field for humankind’s technological evolution.

Categories
Uncategorized

Repost: November 2022 Conference Call

Conference Call Panelists: John Bird, Jason Ware, Liz Bernhard, and Michael Kessler

REGISTER NOW for our first conference call of 2023 scheduled for May 16, 2023 at 9AM.

November 2023 Conference Call from Albion Financial Group
Register for May 2023 Conference Call
Categories
Learn

2022 Market Recap

2022 Market Recap [PDF]Download

2022 Year-End Recap

Inflation:

Post-pandemic inflation was the story for the global economy in
2022, as a combination of snarled supply chains and labor shortages were
exacerbated by Russia’s invasion of Ukraine, which sent energy prices
skyrocketing. Inflation reached a 40-year high in the US in the late spring,
but moderated somewhat in the second half thanks to falling energy prices,
fewer supply problems, and a slowly-but-steadily normalizing labor market.

Monetary Policy:

If inflation was the fuel for the 2022 bear market, monetary policy was the match that lit the flame. At the start of the year, the Fed still had overnight interest rates pinned at zero, and Fed Fund Futures markets were pricing in just three 25bp rate hikes in 2022. Fast forward 12 months, and the Fed has enacted the equivalent of seventeen 25bp hikes, including four consecutive 75bp increases, pushing its policy rate floor to 4.25%. Central banks around the world have followed suit in the fight against global inflation, including the Bank of England, the ECB, and even the Bank of Japan. Looking ahead to 2023, markets are expecting a much more balanced monetary posture, with two small rate hikes expected from the Fed early in the year, and the potential for cuts on the horizon towards the end.

Economy:

The US economy normalized somewhat in 2022, with growth
decelerating after a torrid +5.9% pace in 2021. GDP growth was mildly
negative in the first two quarters this year, but the US has avoided recession thus far, thanks largely to a resilient consumer. Over the course of the year, most gauges of manufacturing activity weakened, and housing decelerated sharply thanks to soaring mortgage rates. Looking forward, Albion’s expectation is that the Fed’s monetary tightening will ultimately cause the economy to enter recession at some point in 2023.

Bond Market:

Driven by the Fed’s sharp pivot to inflation-fighting, US fixed income endured one of its worst years in history. Treasury yields rose by 200- 350bp as the curve became almost completely inverted, and IG credit spreads widened by more than 30bp. No sector of the bond market was spared the decline in prices, although the restoration of yield to decade-plus highs helps to brighten the outlook for fixed income investors going forward.

Stock Market:

After reaching an all-time high on the first trading day of
2022, the S&P 500 spent most of the year in a bear market. Equity returns
were primarily driven by duration exposure, with long-dated growth sectors (especially technology) hit the hardest while dividend-rich sectors fared better. Energy was an upside outlier all year thanks to the dramatic rise in oil and gas prices following Russia’s invasion of Ukraine. International stocks finished lower as well, with China giving investors a particularly turbulent ride in 2022 thanks to Beijing’s ever-evolving Covid and economic policies.

2022 S&P 500 Total Return by Sector

Albion’s “Four Pillars”

Economy & Earnings

US GDP rebounded to +2.6% in Q3 after falling
1H22, and corporate operating margins remain solid at ~12% on the S&P 500 Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 17x is slightly above the long run average. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the single digits. Most or all of this year’s P/E multiple compression has been driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates have risen across the curve in 2022 in response to a shift in monetary policy. Fed Fund Futures are pricing in two additional 25bp hikes in 2023, with a “terminal” Fed Funds rate slightly below 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation has followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is helping to keep services inflation elevated.