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[Season 2 Ep.4] Market Update Podcast

Laila Pence: (00:00)

Good afternoon, everyone. Today is May 20, and this is season two, episode four of our podcast. We have a full agenda this afternoon. We’re going to cover the number one question I’ve been getting asked about, which is inflation fears and interest rates. Then, I’m going to cover the potential of a new recovery act called the Secure Act. Then we’re going to cover what’s going out with the markets right now. What happened in May? What’s going on with the market volatility? We can also cover savings rates in the stimulus, and we have a few client questions and then some action items at the end. So with that, I’m going to turn it over to Dryden, who will answer the number one question that I’m constantly being asked: what is inflation? Are we going to have interest rate hikes? What’s going to happen? Dryden, can you tell us?

Dryden Pence: (00:58)

Sure. Well, thank you, everybody. Glad to see you’re here. When you talk about inflation, you got to figure it out: are we talking about supply constraint inflation, or are we talking about aggregate demand in place? There are two different pieces of this. Now, the first one – I spoke last time about supply constraint inflation, and I talked about the fact that when you have supply constraints, then prices go up. Nothing goes on sale. Why would you put a back-ordered item on sale?

Dryden Pence: (01:48)

So we had supply constraints going on. There was more demand than there was supply. We had supply chains throughout the country affected both by COVID and just this flood of online sales. So that last two pushed the statistics on pricing up, right? Nothing was going on sale. So prices went up, then that moved over to increase the surrounding data. They said, oh my gosh, there’s some inflation. Then interest rates reacted because people got worried about it. There wasn’t inflation. The Fed might raise interest rates. I look from a pure investment standpoint. Now, this isn’t your individual going out and shopping and stuff like that. However, from a pure investment standpoint, the thing to pay attention to is that inflation matters if the Federal Reserve raises interest rates.

Dryden Pence: (02:49)

Here is the thing to know: the Federal Reserve wants inflation. They are telling everybody we want inflation. We want an average inflation rate of around 2%. The problem is that they’ve only had inflation over 2% twice in the last 11 years. The Fed wants inflation. They’re not getting it. Inflation could go to 3% and stay there for five years before they ever get back to the numbers they’re trying to get.

So the critical issue here to pay attention to is that the Fed wants inflation. Therefore, they will not be excited about raising interest rates in a precipitous matter. They can withstand inflation north of 2%, like 3%, even 3.5% for a good while before they ever get back to where they want to be. The other important thing – they learned this back in 2018, and Jay Powell was chairman then, and he’s chairman now – is the price elasticity of demand for interest rates.

Dryden Pence: (04:02)

If interest rates go up, the Fed is doing that to change behavior. They have found that a quarter percent increase in the interest rate today gets them the same response as if they had raised the interest rates for almost a full percent ten years ago. If rates were higher ten years ago, they had to raise it more to get a response. Now, statistics rates have been so low. They only have to trim the sails just a little to get a consumer response. So here’s our general view of this: inflation exists. They want it to exist. It’s going to exist now – not from a supply constraint thing, cause that’s all leveling itself out. You’ve seen oil prices come down and things like that.

Dryden Pence: (04:59)

But it does that by aggregate demand because the economy is doing pretty good, and the Fed wants that to occur. It will not push them to raise interest rates for a long while. So when you have this movement, if they do raise interest rates, they’re only going to raise it a little at a time, and it will all get well broadcast.

So right now, the media is talking about the fact that inflation’s come back and interest rates will rise. Not so much. So the best thing to do is recognize the people who control the interest rates at the short end of the curve can control it longer through operation twists and stuff like that have made it very clear.

Dryden Pence: (05:51)

They’re not interested in raising interest rates anytime soon. If we do, it’ll get well broadcast. So the thing to do is take a breath and relax. You will not see this precipitous stuff. This has created some volatility. You just kind of need to let it wash over yourself because we don’t believe that it’s anything to worry about because it will not spur trading with the Fed. Now let’s talk about other policy issues, and we’ll move from the Federal Reserve policy to Laila, who’s going to talk about fiscal policy and the Secure act unless she’s got a question for me.

Dryden Pence: (06:23)

let’s move to Laila. Who’s going to talk about fiscal policy and the secure act unless she’s got a question for me.

Laila Pence: (06:41)

Yeah, I do. It’s also true that we have 10 million more people who are unemployed than there were before. That’s one thing that the Federal Reserve is going to wait on – until unemployment goes down. Dryden, the question I get asked is why did the 10-year treasury rates go up while the Federal Reserve is still not raising interest rates in the short term?

Dryden Pence: (07:29)

Well, you saw the 10-year treasuries go up. This was part of this anticipation of inflation. This was a reaction to that supply constraint – a price rise that we talked about. If you notice, it peaked up, and then it came back down, and it’s going to be adjusting. The point is where the Fed controls: the short end of the curve. The ten-year is really controlled more by the market. You want to have an upward-sloping curve. You want short-term, short tenure to be at about medium, and then 30-year long-out.

Dryden Pence: (07:29)

But the Fed now understands and can do the thing called “Operation Twist.” They did this back in 2013; they step on different parts of the interest rate curve when they feel like it gets too hot. So what you’re going to see is you’ll probably see the ten-year pick up a bit, and then it’s probably going to come back down and normalize. If it gets too out of whack, the Fed will come in, and they’ll push it down. They’ve done that before. They know how to do it. So again, while you’ll see some increases in interest rates, which is normal in a healthy and robust growing economy, which is what we have, I don’t think you’re going to get this massive skewing of the curve.

Laila Pence: (08:25)

So now I’m going to talk to you about something that will be very interesting to many of you who have not retired yet. So if you remember, at the end of 2019, the Federal Reserve passed the Secure Act, which delayed required minimum distributions to wait until age 72. At the end of last year, they introduced the Secure Act, which I’ve discussed in one of these podcasts. They got into a lot of other issues, and that bill did not pass. However, on May 5th of this month, the good news is that this year, the Ways and Means Committee in the House passed this Secure Act by a vote of 417 to 3. That’s one of the few bills that have very high bipartisan support. So that’s how the Secure Act passed. Secure Act two just passed that Ways and Means Committee by a substantial percentage of the House.

Laila Pence: (09:37)

We think they will get introduced to the whole house, get voted on, and eventually go to the Senate. But this is still just proposed, so please don’t take what I’m going to be talking to you about here as fact, but there’s a high likelihood that it’ll pass with some changes. So here’s very, very good news. It will increase the RMD, a Required Minimum Distribution, from age 72 to 73 for those retiring or those getting to age 73 by 2022. Then it will increase to 74 in 2029 and then to 75 in 2032. People live a lot longer, and they don’t want to require people to take the minimum distributions very early because people live a lot longer.

Laila Pence: (10:36)

If you don’t take your required minimum distribution when you’re supposed to, there’s a huge penalty of 50%. They’re proposing to reduce that 25% as a penalty. You can tell them you know you made this honest mistake and fix it right away; then the penalty would drop to 10%. There also would raise the catch-up contribution limits. So those were age 50 right now; the catch-up is 6,500. They would increase that to 10,000 from 6,500.

So there would increase the catch-up contributions. They would also allow the traditional IRA catch-up limits to be indexed to inflation starting 2023, so you’d be able to contribute more money. They will require employees to automatically enroll eligible workers and 401ks reports with the plan at a savings rate of 3% of salary. They would allow employers to provide financial incentives like small gifts to increase contributions to 401k.

Laila Pence: (11:52)

They would allow companies to make matching contributions based on student loan payments. That’s in 401k, a Simple IRA, or a 457. So if you have a child or you have loans outstanding, you could make contributions. Those loans would reduce the eligibility for part-time workers who work at least 500 hours, going from three to two years. Last but most important, for many of you right now, if you have an IRA and you are in the RMD age over 70, you can give a hundred thousand dollars of your IRA of your requirement’s distributions directly to a charity and not have it counted as income. They’re proposing to increase that to 130,000, which would be a fantastic thing for those of you who are charitable and don’t want to pay taxes on your RMD. So a lot of excellent changes.

Laila Pence: (12:53)

I’m sure there’s something there that they’re going to do to raise taxes to pay for this, but that is not out yet. They do realize that we have a retirement mess in this country. People are not saving enough for retirement, and they are doing something about it. We think this has a good chance of passing with some changes. So stay tuned. When it passes, I will be back and give you all the details. Now I’m going to turn it to the major questions of the afternoon, which cover what happened in May to the stock market and what’s going on in the various sectors. Dryden, can you cover that?

Dryden Pence: (13:42)

First, what you see going on right now are two things. You’ve got headline volatility, and you have what I call calendar volatility. I’m going to cover headline volatility first. This is why we spend a lot of time trying to look behind the numbers. So the first issue goes back to this inflation thing we were talking about. People need to recognize that while the news media reports CPI, consumer price, and index inflation, but the Federal Reserve and the investment team at Pence Wealth Management focus on a much more accurate term called personal consumption expenditures, what people actually spend their money on. That’s very important because it’s a more precise term, and it gives us a better idea OF consumer behavior. I’ll give you an example. If you look at April’s core CPI year over year, it’s up 3%, and everybody’s going, oh my God, it was 3%. However, if you just pulled out used cars and trucks, it was actually 2.3%.

Dryden Pence: (14:46)

So what you see in the news and what the Federal Reserve is looking at, or what we should look at as investors and economists are sometimes two very different things. Just like when you hear people talking about, oh my goodness, look at how high the price-earnings ratios are. Well, most people don’t realize that if you look at the big index in the headlines and stuff like that, sometimes you’re going to get a skewed view. Right now, if you take the top 20 companies in the Q2 or the NASDAQ 100, the PE ratio is up to 39.8, and that’s really high. However, if you pull out one company, which is Tesla, you actually see that the PE ratio is really 24.2, which is more normal and back to where it is even below the S&P.

Dryden Pence: (15:40)

So you have this moment where most large companies, even technology companies, are actually in a relatively good position of value. Their PE ratios are actually below that of the S&P index in some cases. We had this big run-up in the S&P stuff; that’s actually ahead of companies with dramatically strong earnings. So it’s very easy to see how paying attention to headlines can give you a skewed view of the market. The fundamental thing to recognize here is when you think about corporate buybacks and repurchase authorizations in 2021, they’re at an all-time high of $504 billion. Corporate CFOs know the most about their companies.

Dryden Pence: (16:38)

A corporate CFO is taking money and buying back their shares is saying that the market undervalues my company today, and the best place for me to put money is actually in my own company. So I think you have to recognize that you’ve got to be careful what you listen to out there versus what’s going on. This is the headline volatility. I talked about the other volatility in the market. I already talked about how people overreacted to this inflation number and this interest rate movement that traded some sell-off in tech, but it’s now stabilized. The other piece of volatility that people are forgetting is calendar volatility. What I mean by that is two big things have happened. Remember, last year, we had this tremendous run-up in the market where we’re a little over a year beyond that.

Dryden Pence: (17:27)

We bought them back in March a year ago, and then we had this big run-up. Well, guess what’s happened, right? Starting in about April 1st, all these companies that people bought that they’re maybe a hundred percent in hit long-term capital gains. You got to ask yourself, you’ve got long-term capital gains on a profit like that. You got to ask yourself the big question. Do you think taxes are going to be lower this year than they are next year? Most people will say, yes, capital gains taxes are lower this year than they’re going to be any of the next several. So the point of the matter is, you’re better off selling now and paying the capital gains tax now while the rate is probably lower than it will be next year. So now you see many people selling some of their profits, which puts a cap on where the market can go.

Dryden Pence: (18:19)

Some of the high flyers, now there’s a lot of pressure to sell them driven by taxes. We think the market will continue this choppy piece of calendar volatility through the end of August. So we’re going to see that now that’s going to create some opportunities for us. What do I always say? Those of you that have been clients of this firm for a long time know that I always say you take advantage of volatility and not be the victim. We can think clearly about how we can take advantage of this. The other piece of calendar volatility that happens is that what normally happens in April of every year. You have tax day, and you can go back and look at the selling that takes around that because everybody needs to pay their taxes.

Dryden Pence: (19:06)

Year after year after year, there’s frequently this sell-off – probably around 4% – of that happens in March and leading up into May. There’s a slight dip in the market. Everybody needs to get liquid to pay their taxes. What happened this year? Tax day moved. So the normal volatility from tax selling that you would have seen in April moved to May. That’s part of what’s happened in the last week or two. So you see this selling pressure driven by tax policy and the calendar combined with the interest rate headline volatility that comes in the pressure. That’s worked us through this period, where the markets have bounced around for a little while. Folks, the market will be a little bouncy and have some volatility and be kind of choppy until we get past this tax issue.

Dryden Pence: (20:00)

That’s going to be like in August. The other thing is you get a 10% correction in the NASDAQ frequently. So it happens, and then you bounce off of it. What we’ve seen are just normal market phenomenons. We’ve been through this situation dozens of times in the last decade. We believe that this is a pattern that we can work through, and it’s not something to get significantly concerned about. There are tremendous opportunities abounding out there as we both take advantage of the volatility. Then there’s only one other point I would make: the world is getting better from COVID at a different rate. So some parts of the globe are getting better faster than others.

Dryden Pence: (20:52)

This allows us to playtime machine, right? We’ve done this in the past, folks, where we say the United States is getting better, faster than Europe, or it’s getting faster than Asia. It’s getting faster than in other parts of the globe. We can sit back and look and say, okay, what companies did really well here in the United States as we recovered; let’s look at the same thing in other parts of the world that are going through a similar pattern just 9 or 10 months afterward. You’re going to see some opportunities internationally as we get what I call the do-over of global recovery. So I hope that answers your question about where we are and why.

Laila Pence: (21:39)

Very good. All right. I’ve talked several times about the savings rate in the United States. It’s gone up even more. So right now, the savings rate, because of all the stimulus and because we can’t travel or spend on all the things we usually spend on, is $1.6 trillion. There’s three times the growth in consumer spending. So even if the consumer spends, they have to spend three times as much as they used to eat up their savings. Which bodes well for the economy and really bodes well for the second half of the year. We do think there’s a lot of pent-up demand. There’ll be a lot of spending, and that is a direct cause of the stimulus. Of course, people will go back to work, and we’ll focus on companies that will benefit from that as well. Earnings should show up, and prices will catch up to the earnings. We’ll catch up to the prices. So we’re looking forward to seeing that in the second half of the year. Along those lines, Dryden, we have supply questions. The number one question – back to inflation – is there any investments that you use inversely related to inflation?

Dryden Pence: (22:57)

Inversely related to inflation means when inflation goes up, the investment goes down. I think the big thing is bonds. We primarily focus on equities, and we try to stay fairly short on money. So if we see some inflation, I’ve already talked about how I think it’s fairly muted and will be for a while. But if we see inflation, you’ll see that it harms the bond market, particularly the long end of it. Now that doesn’t mean there aren’t opportunities in bonds. The thing to do is wait for everybody to panic, create some bargains, and then take advantage of that. The other areas in an inflation environment you can see some improvement in are commodity-based products or suppliers and some raw materials and things like that.

Dryden Pence: (23:56)

Those companies can usually push through a pricing structure. You want to ask that who can push through pricing so that they can take advantage of this. The other thing that I want to bring up: Laila, you talked about how everybody’s got a lot of money, right? That means you will not see things on sale. Everybody who’s selling a product is going to get full price. So when we look at prices paid, companies are going to see margin expansion, right? If they could push through a price increase because there’s at large aggregate demand, you’re going to see earnings expand there. So we want to specifically look for companies that can push the price increase that increases their profit margin, and those are important. So you have to do this company by company, which is what we do.

Laila Pence: (24:54)

Other questions: Could Biden change tax rules regarding Roth plans? So one thing I forgot to mention in the Secure Act Two: a part of what the government is going to be doing is in the catch-up provisions, allowing more contributions to go into Roths. The whole reason there is a Secure Act Two is again, Congress recognizes people need to save more money. One way they allow them to save money is through Roth contributions. The fact is, when they do Roth conversions, they get the tax money now. If they allow more contributions to Roth, people still pay the tax on that money.

Laila Pence: (25:43)

So we don’t think there’s going to be any changes. As a matter of fact, they’re beefing up Roth plans, which, as you know, I am very in favor of. This year, it is one of the action items specifically to do more Roth conversions because we believe if you’re in a higher tax bracket, this year could do one of your lowest tax years that you can have. This is an excellent year. If you can afford to pay the tax from your personal funds to do more Roth conversions and let that growth happen tax-free, there’s nothing more potent than having tax-free compounding for you and your heirs.

Dryden Pence: (26:26)

I want to add something about this for those who have listened to this podcast all of last year. Laila was really banging the drum very hard last year about Roth conversions, and many people did that. Those people who did Roth conversions paid some taxes. Then we took advantage of that volatility, and we could move that money. It’s probably done pretty well over that period. The benefit of a Roth conversion was tremendous for these individuals. I think that that’s something you should pay close attention to because it’s still a good opportunity. Taxes are probably lower this year than they’re going to be the next couple of years, and you need to do things when they’re on sale.

Laila Pence: (27:29)

One other question: is this a good time to add funds? Absolutely. Especially right now, as we’re getting some volatility in the NASDAQ and the technology area, which is an area that we favor, this is really a good time. It’s also the time to do Roth conversions. I just did a big conversion yesterday. When the market was bad the last couple of days, I said, let’s convert now to get these lower prices. What’s great about Roth conversions is we don’t have to sell; if you have a holding in your IRA, just transfer it. You know people say, why do you, why do you think Roth? Why do you do that? And why do you make me pay more taxes? Most advisors never want you to do that. They want you to keep all their money here because you’re not paying taxes; you’re leaving it for the advisor to invest.

Laila Pence: (28:10)

We want you to look down the road10 to 20 years, and you will think this is one of the best pieces of advice we can give you. Yes, you pay some taxes. Pay the taxes. Use some of your RMD. If you don’t need it, let’s take that on the incentive to taxes and do more Roth conversions. It is a great strategy. You will remember this for years and years to come. So will your kids because, as you know, your beneficiaries only have ten years to take the money out with the Secure Act. What you do is you leave them with a tax bomb if you don’t reduce some of your retirement money now.

Dryden Pence: (28:48)

I’m going to do one rejoinder to that. Everybody knows my wife, Laila, loves things on sale. So whenever she sees something that’s on sale, she wants to do it. So frankly, if you think about now through the end of the year, you know, probably taxes are on sale. Now’s probably a good time to do those things so we can plan better for the future. So that’s a rejoinder for that.

In summary, we think that there’s going to be some volatility. There always is. We think that parts of the market come oversold relative to what they are. This is a period where I think earnings are continuing to come in very strong. So the quality of prices is going up, even though the stock price may not be rising as fast as it was last year. The quality of that price is the stability of that price is going up because the earnings are coming in behind it. We want to take advantage of that while we can.

Dryden Pence: (29:51)

So it is an opportune time to put money to work to improve the overall quality of portfolios over time. With that, I want to remind everybody that the next episode is going to be Wednesday, not Thursday, Wednesday, June the 30th. We’ll have another episode of the podcast. It’s Wednesday; mark your calendars. And also, remember that the client luncheon will be on September the 18th, and that will be in person. It will be no California COVID restrictions.

We look very much to seeing everybody there. I will say this, I did my first live presentation last week to about 40 folks down in San Diego, and it felt so good to be back on stage. There will also be a Zoom option for those of you who can’t be here in person, so we’ll be hybrid. Certainly, for those of you who could come and be with us, it will be Saturday, September 18th. Mark your calendar and tell your friends about it. With that, I bid you good afternoon until next time. Thank you so much.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Historical performance is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All investing involves risk including loss of principal.

No strategy assures success or protects against loss. All company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets. Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA. Unit Investment Trusts (UITS) are a fixed portfolio of securities with a set term. Strategies are long term, therefore investors should consider their ability to pursue investing in successive trusts and the tax consequences.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

Pence Wealth Management does not provide legal and/or tax advice or services.  Please consult your legal and/or tax advisor regarding your specific situation.

Laila Pence is a registered representative with and securities and advisory services offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC. Financial planning offered through Pence Wealth Management, a Registered Investment Advisor.

Dryden Pence is a registered representative with and offers securities and advisory services though LPL Financial, LLC (“LPL Financial”) member FINRA/SIPC and a registered investment adviser. Mr. Pence may offer financial planning services through Pence Wealth Management (“PWM”), a registered investment advisor.

Pence Wealth Management (“PWM”) is a sophisticated financial services practice within LPL Financial, LLC (“LPL Financial”) comprised of multiple financial professionals that provide a series of services including personal investment advisory, third party managed advisory and brokerage services. Pence Wealth Management, Inc. is an investment adviser registered with the State of California to provide financial planning services. The financial professionals affiliated with PWM are registered with and offer securities and investment advisory services through LPL Financial, member FINRA/SIPC and a registered investment adviser. As of 4/1/21, the total assets serviced by PWM through LPL Financial consist of $1.7 billion in advisory assets and $300 million in brokerage assets.

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