October 6, 2021
There is a chill in the air this week, bringing forth thoughts of another change of the season. We are stocking up on candy this year with high hopes of our first real Halloween in two years. We are also cautiously optimistic that we will be able to safely gather with family and friends for Thanksgiving this year.
Third Quarter 2021 in Review
According to St. Louis Federal Reserve data measuring monthly S&P 500 performance over the last 50 years, September has historically been the worst month for stocks. If you wonder whether the trend has abated in recent years, the answer is no; it has not. In the previous ten years, September's performance has been substandard.
While analysts have offered various explanations, no one has pinpointed why we sometimes see seasonal weakness as summer concludes.
Look no further than the table of Key Index Returns. The S&P 500 Index fell 4.8% in September. It was the first monthly decline since January and the worst decline since March 2020, when the lockdowns began.
Key Index Returns
Dow Jones Industrial Average
S&P 500 Index
Russell 2000 Index
MSCI World ex-USA*
MSCI Emerging Markets*
Bloomberg Barclays US Aggregate Bond
Source: MSCI.com, Bloomberg, MarketWatch
MTD: returns: August 31, 2021—September 30, 2021
YTD returns: December 31, 2020—September 30, 2021
*in US dollars
Peaking at a new record on September 2, the broad-based S&P 500 Index began a pullback that can be tied to several factors.
Before we continue, a 4.8% drop is modest by market standards. We have yet to shed 10% since the bull market began in late March 2020. A 10% decline is significant because it is considered a "correction" by analysts.
So, what was behind the sell-off last month?
The economy is not contracting, and we expected a moderation after Q2's 6.7% annualized growth rate (U.S. BEA). However, the slowdown has been more pronounced than expected.
The Atlanta Fed's GDPNow model, which incorporates economic data that impacts GDP, suggests that Q3 growth is tracking at just 2.3%. This model includes Q3 data released through October 1. That means July and most of August, but none of September's data are included in the model.
While profit growth has soared coming out of the lockdowns, per financial data analysis firm Refinitiv, a more pronounced moderation in profit growth may be on tap.
Next question, why is Q3 disappointing on the economic front? The spike in Covid cases is causing some hesitation in industries that are dependent on face-to-face transactions. But there is good news on this front. The CDC reports that new cases have slowed recently. We can only wait and see how this trend continues to play out this fall. However, Dr. Anthony Fauci recently said that Thanksgiving and Christmas gatherings could go back to a pre-pandemic version of normal for the fully vaccinated. We also see stubbornly high inflation in some industries, as supply chain bottlenecks are not fixing themselves.
Consider the title of this Wall Street Journal story from August 26, 2021, which sums up the problem for many manufacturers: "Why Is the Supply Chain Still So Snarled? We Explain, With a Hot Tub." The article describes how Utah manufacturer Bullfrog Spas depends on a complicated network to bring materials from across continents and oceans. The pandemic threw that supply chain out of whack.
As Fed Chief Jerome Powell noted at the end of September, bottlenecks and shortages of critical raw materials are "not getting better—in fact, at the margins (they are) apparently getting a little bit worse."
Like severe labor shortages, supply chain problems are crimping profitability, limiting sales, raising prices, and hampering economic growth. Investors cannot help but take note.
An uptick in bond yields near the end of the month also dampened sentiment. While yields remain quite low, they ticked higher after the Federal Reserve took on a slightly more hawkish tone at the September 22 meeting.
These are probably the biggest reasons for the pullback last month.
Not to be Debbie Downer, but let's look at a few more.
The debate over the debt ceiling is taking shape. The U.S. Treasury has said it will run up against the current debt ceiling on October 18. That means it can no longer borrow to fund operations, and the U.S. would default on its debt unless Congress raises the debt ceiling.
As Moody's Analytics recently noted, "The debt ceiling will be raised. Not doing so would be catastrophic for the economy, so this is an extremely low probability event."
We have seen this drama play out before, and lawmakers avoided sailing into uncharted waters. Still, it is causing some headline anxiety.
China's largest and most indebted property developer is on the brink of bankruptcy. While Western financial exposure is likely limited, a disorderly default could create significant problems for the world's second-largest economy.
Finally, an energy crisis is brewing in Europe, while natural gas prices hit new highs in Asia. They are running about six times what we see at home.
The U.S. is not directly affected, but these are costs that may get added to manufactured goods or could restrict output, adding to supply chain woes.
We are overdue for at least a 10% correction. We know that corrections of this magnitude are unpleasant, but they are part of the investment landscape. Statistically speaking, we expect a 10% correction about once per year.
As we have noted in the past, stocks tend to take the stairs up and the elevator down. If we are headed toward an overdue correction, the good news is that pullbacks tend to be short-lived.
Will Tax Law Changes Increase Your Taxes?
If proposed changes to the tax code are enacted into law, those that are wealthy, as defined by lawmakers, will likely see their taxes rise.
The major provisions include:
- Raising the top federal tax rate from 37% to 39.6%
- Raising the tax on qualified dividends and the long-term capital gains tax rate for assets held over one year to 25% (up from 20%) for individuals earning more than $400,000 and for couples that earn over $450,000
- Placing new limits on those who have retirement account balances above $10M
These proposals are a long way from becoming law but are winding their way through Congress. The Senate may have its own set of proposals, which would require both legislative bodies to forge a compromise before a tax bill lands on the President's desk.
Moreover, a sharply divided Senate seems likely to pare down the $3.5 trillion in proposed spending, assuming legislators in the House compromise on new outlays. If new spending is reduced, smaller tax hikes could follow.
While a wait-and-see approach may serve some folks well, we understand that planning for any changes reduces the odds of an unwanted surprise.
We are providing general guidelines. We understand that your situation is unique. We would be happy to entertain any questions and tailor our recommendations to your needs.
The top tax rate is going up. If proposed changes are enacted, a couple filing jointly with $600,000 of taxable income will see their tax rate increase from 35% to 39.6% next year (an increase of 4.6 percentage points, or a $6,900 increase in taxes on $150,000 of income).
However, there are ways to minimize the tax sting next year.
Consider shifting 2022 income into tax year 2021, which would be subject to today's lower rate. And look for ways to defer expenses and deductions that you might typically incur in 2021 and push them into 2022.
Maximize contributions to tax-deferred savings and retirement accounts. If you itemize deductions, charitable contributions will reduce your taxable income.
In addition, municipal bonds, which are exempt from federal income tax, will become more attractive if a higher marginal tax rate is enacted.
A higher rate on dividends and long-term capital gains tax rate are being considered. As proposed, if a capital gain is realized on or after September 14, 2021, individuals earning more than $400,000 and couples earning over $450,000 will pay a top rate of 25%. The same would hold for qualified dividends. In a move designed by Congress to prevent selling between the release of the proposal by the Ways and Means Committee and being signed into law, it is now too late to incur any long-term capital gains at 2021's lower rate.
You may consider deferring gains, as an unrealized capital gain would not be subject to taxes. As we commented above, much depends on your individual circumstances.
There will be new RMD requirements for individuals with high income and large retirement accounts, regardless of age. If you exceed $400,000 and $450,000 in income for single and joint filers, respectively, AND retirement accounts total over $10 million, you will be subject to RMDs beginning in 2022. You will also be prohibited from making IRA contributions.
However, the contribution restriction does not apply to employer-sponsored plans such as 401ks, SEP IRAs, or SIMPLE IRAs.
If your income is above the $400,000 and $450,000 limits and retirement accounts exceed $10 million (including a Roth IRA), you would be required to distribute funds from your Roth IRA.
Left on the cutting room floor
Lawmakers in the House have not proposed taxing unrealized capital gains at death, as President Biden initially proposed. Also, the step-up in basis for inherited assets is NOT in the current House proposal.
But one proposal being floated is to reduce the estate and gift tax exemption to $5 million. Tax reform in 2017 raised the limit to $11.7 million for individuals and $23.4 million for couples.
These are some of the major provisions. They may or may not be enacted into law.
We understand that taxes play a role in overall returns, but so do many variables. Your financial plan should ultimately drive investment decisions, not tax laws. Don't let the tail wag the dog. In other words, be careful not to let taxes solely dictate your investment decisions.
Let me emphasize that it is our job to assist you. If you have any questions or would like to discuss any matters, please feel free to give us a call.
As always, we are honored and humbled that you have given us the opportunity to serve as your financial advisor.
The Silicon Valley Wealth Advisors Team
Tracy Lasecke, CFP® Chris Duke, CFP® Scott Ponder, MBA, CFP®
Scott Yang, CPA, CFP® Monique Ruiz Lisa Ozaki
Personal Notes @ SVWA
Tracy and Roberta - It’s a been another summer that has flown by despite the travel restrictions and seeming lack of opportunity for good times. Roberta traveled to Wisconsin the celebrate her Mom’s 86th birthday. Congrats Carol! Tracy took his car to the racetrack a few times, played a little golf and enjoyed visiting friends, clients and family. Roberta and Tracy are planning a trip or two hoping that they will actually happen!
Chris and Laura - After nearly 3 years of planning, we were able to make a trip to France before the Delta variant was on anyone's radar. Due to shifting travel restrictions the itinerary had to change dramatically just two weeks before departure, and there were serious questions about whether we would need to cancel just 48 hours before getting onto a plane. In the end the trip came off without a hitch, and we felt incredibly safe the entire time. This served as a testament that there is light at the end of the tunnel, and a return to some form of normalcy is imminent.
Scott and Erin- Scott & Erin have been taking advantage of the nice weather by hiking and gardening. We also spent some time with our niece and nephew before they went off for their first year of college.
Scott Yang - Scott’s wife returned to teaching in the classroom and both his kids are now at San Jose State University. Scott has been trying some new wines and looking for some good hiking trails.
Mo and family have settled into the school year comfortably. It is senior year for the youngest son, Go Bells! We are reviewing colleges and working on applications.
Lisa Ozaki traveled to Portland and visited Multnomah Falls. She was excited to try all the different donut shops, but many of them were closed on Monday-Wednesday. On her free time, she finished watching The Handmaid’s Tale and Squid Game.
Charles Tran passed his Series 65 in August just four months after starting at SVWA. He began CFP education courses at UCSC Financial Planning Extension in September, and just went on a trip to San Diego to celebrate a friend's birthday.