Photo Credit: الإعلام الحربي اليمني, CC BY 4.0, via Wikimedia Commons
INVESTMENT ENVIRONMENT1
Source: Orion Advisor Services, AlphaGlider
The fourth quarter was an extremely strong one for both stocks and bonds, in a year with many strong quarters. Our fixed income benchmark, the Bloomberg US Aggregate Index,^e was up 6.8% while our global equity benchmark, MSCI ACWI IMId increased 11.1%. Emerging market stocks lagged their developed market peers, but still put up a solid 7.9% gain during the quarter.
With its large weighting in technology companies, the US led global equity markets for the full year of 2023. The S&P 500a posted a total return of 25.7%, well ahead of foreign developed markets (MSCI EAFEb +18.2%) and emerging markets (MSCI EMc +9.8%). With the strong showing in Q4, bonds were able to salvage a solid year, with the Bloomberg US Aggregate Index turning in a 5.5% return.
The big financial story of 2023 was that of the recession that never arrived. Exiting 2022, 85% of economists [paywall] expected a US recession in 2023 and sell side economists set their 2023 year-end S&P 500 price targets accordingly. When the recession did not arrive, the S&P 500 blew past all expectations for 2023 as shown in the chart below (for perspective the S&P 500 started the year at 3,839.5).
By raising rates aggressively, the Federal Reserve (Fed) helped reduce core consumer price index (CPI) (excluding volatile food and energy) from 5.7% in December 2022 to 3.9% in December 2023, all while not crashing employment (3.7% unemployment in December, up only 0.2 percentage points over the year), and growth in wages, consumer spending, and economic activity. It would appear that much of the inflation we saw was indeed “transitory” and naturally unwinded as supply chains recovered from Covid disruptions.
Also helping the US economy avoid recession since the Covid outbreak was the US government’s aggressive fiscal stimulus that caused its debt to increase $10 trillion to its current level of $34 trillion. Think Covid-related programs like the CARES Act and the American Rescue Plan that flooded business and individuals alike with cash, infrastructure plans like the CHIPS and Inflation Reduction Acts that are spurring capital spending, combined with a tax code that generates low levels of revenue relative to other developed countries. Below is one chart that especially caught our attention this past quarter. It tracks the massive spike in US manufacturing construction spending, mostly from computer, electronic, and electrical manufacturing, all thanks to the two above mention infrastructure plans.
Source: Axis Visuals, US Census Bureau
Although December’s core CPI was 3.9% higher than a year ago, the annualized rate over the last three months of 2023 was a more modest 3.3%. With the Fed’s 2% inflation target in sight (although it must be noted that the Fed looks more closely the Personal Consumption Expenditures (PCE) Price Index which has not yet been reported for December), the bond and stock markets have fully embraced that the Fed will cut rates aggressively in 2024. At present, the bond markets are pricing in a two-thirds chance that the Fed will begin cutting in March, and get rates down to approximately 4% exiting 2024. However, the Fed itself is only guiding to 4.5-4.75% exiting 2024, perhaps haunted by the Fed’s past failures to rein in inflation in the 1970s. While correlation does not imply causation, there are some disturbing similarities between the 1970s and today (see below) that we suspect are causing some Fed members to be reluctant to begin cutting too soon or too quickly.
Source: @Barchart
The inflationary trends in Europe are broadly similar to those in the US, and thus the bond market also expects the European Central Bank (ECB) to begin cutting rates in the first half of this year. 2024 is a big election year with nearly half of the world’s population and GDP going to the polls. One of the first elections was in Taiwan last weekend where a Democratic Progressive Party (DPP) candidate won a third consecutive term. The DPP is a stronger advocate for an independent Taiwan than rival parties which may cause China to escalate economic and military pressure on the country over the coming months. Other key elections will occur in the European Parliament, India, Indonesia, Mexico, Pakistan, Russia, and of course, the US.
At the moment, Trump and Biden are running close to one another for the US presidency in the betting markets. As shown in the previous chart, bettors on PredictIt.org are paying 45 cents to receive a dollar if Trump wins, which roughly translates into the betting markets thinking he has a 45% chance of winning the election. Biden is currently being given a 40% chance.
It is an understatement to say there is a lot at stake in upcoming US election. Although the government will be run very differently depending on the outcome, the trajectory of the US economy and in turn, the US stock market, will likely be little changed. So while you may get worked up as this election year unfolds, know that historically politics has not had much impact on one’s investment portfolio. The chart below shows the growth of $1000 invested in the S&P 500 from 1933 to today, on a log scale (yes, it would be well north of $10 million now). With the sole exception of George W. Bush’s administration which was unfortunate to experience the bursting of two market bubbles, the S&P 500 has always gone up over a party’s consecutive terms in control during this period, regardless of it being red or blue. The chart urges you to reject the temptation to jump in or out of the market due to politics. It is not your timing of the markets, but rather your time in the markets, that matters most to your long-term investment returns. That and paying attention to costs and taxes while you accrue your time in the markets.
Source: Capital Group
Staying on the theme of US politics, we are again staring down the barrel of another potential government shutdown should Congress fail to agree on a short-term funding extension this week — 20% of the government set to shutter on 19 January and the rest on 2 February. Earlier this month Republican House Speaker Mike Johnson and Democratic Senate Majority Leader Chuck Schumer agreed to a $1.66 trillion top line spending level for fiscal 2024, but their two parties remain far apart on how this total will be divvied up among government agencies. The top line spending agreement is similar to the one President Biden and previous Speaker Kevin McCarthy agreed to last spring, the same agreement that caused ultraconservative House Republicans to remove McCarthy as its speaker.
Johnson really only has one path to passing a spending bill, and that entails a bipartisan agreement between Democrats and centrist Republicans in the House — but taking it may result in the ultraconservatives ousting him as speaker like they did McCarthy. His other option is a government shutdown, extremely unpalatable for his party in an election year. Either way, past government shutdowns have had minimal impact on the economy and markets in the past, and we do not expect that to change this time around.
Ukraine is incurring collateral damage from the budget standoff in Congress. The same ultraconservative House Republicans who threaten to remove Johnson from his post have held back critical military aid to Ukraine as leverage to get the Democrats to reinstitute Trump’s “remain in Mexico” policy and hundreds of miles of new border walls along the Mexican border.
As the war in Gaza nears the 100 day mark, it is the risk of the conflict spilling over into neighboring countries that keeps the attention of the investment markets. Thus far the war has triggered a low-level conflict between Iranian proxy forces and the US and other Western powers in Lebanon, Syria, Iraq, and Yemen. The Iranian-backed Houthis in Yemen have successfully used their location on the Red Sea to restrict ship movements through the Suez Canal, a waterway that sees approximately 12% of global trade and 30% of global container traffic pass through it. During the first 11 days of January, ship traffic was down 30% compared to the previous year as many shipping lines choose to reroute around the Cape of Good Hope. As a result, shipment times and costs have gone up significantly for this important route, and to a lessor extend on other routes elsewhere.
One cost that has surprisingly not increased during this Middle East crisis is crude oil. Thanks to surging supply from the US and sluggish demand from China, the price of oil has fallen nearly 20% since the war in Gaza began.
PERFORMANCE DISCUSSION
Fourth Quarter
Although all up in the mid to high single digits, AlphaGlider’s various investment strategies fell short of their respective benchmarks by approximately 10 to 20%. The primary contributor of this relative underperformance was our strategies’ equity positioning. Our strategies were hurt by their small (~10%) underweighting of equities (MSCI ACWI IMI +11.1%) relative to their benchmarks, their large underweighting of the US market (S&P 500 +11.6%), and their more modest overweighting of emerging markets (MSCI EM +7.9%). To a lessor extent, our strategies were hurt by their preference for value and quality stocks over growth stocks.
Within our fixed income portfolio, our strategies were somewhat hurt by their slightly short duration relative to our fixed income benchmark, as well as their overweighting of safer government-issued bonds. Likewise, our market neutral equity fund2 performed well in absolute terms, but not as strongly as our fixed income benchmark.
On the positive side, our strategies were helped by their overweighting of interest-rate sensitive equities, notably US small caps and international real estate. And although emerging market equities dragged down performance, our strategies’ relatively new positions in emerging market bonds were especially beneficial this quarter.
With energy prices weak during the quarter, our ESG investment strategies outperformed their Core investment strategy peers due to their structural underweighting of fossil fuel companies.
Last 12 Months
As in the fourth quarter, our defensive management resulted in AlphaGlider investment strategies falling shy of their respective benchmarks by ~20% during the full risk-on year that was 2023. This was a year to have the pedal to the medal, a year to invest in the highest risk, highest growth, highest valued stocks and bonds — which we weren’t.
The drivers of our strategies’ performance were remarkably similar to those in the fourth quarter — not too surprising given that the fourth quarter’s moves were disproportionately large relative to those during the year’s previous three quarters. However, there were two additional large relative drivers of our full year performance: 1) the strong performance for our market neutral equity fund held by all of our strategies and 2) poor performance from companies exposed to clean energy that were held by our more aggressive ESG strategies.
LOOKING FORWARD
Without any recent changes to our investment strategies, I will dedicate this section to some timely odds and ends that may affect you financially over the coming weeks, months, and years. Please reach out to me with any questions.
Gift & Estate Tax Exemption Thresholds
First off are the federal estate and gift tax exemption thresholds, which are set to halve on January 1, 2026. If you have a sizable estate, now may be a good time to review your estate plan to ensure this change does not trigger a potential tax liability.5
As you may recall, the federal estate and gift tax exemption thresholds were temporarily doubled through 2025 by the 2017 Tax Cuts and Jobs Act. As of 2024, an individual can gift (and/or pass along upon death) up to $13.61 million, and a couple up to $27.22 million, without triggering federal estate and gift taxes which can be as high as 40%. The Internal Revenue Service (IRS) adjusts these exemption levels annually for inflation. Unless Congress makes the change permanent, we expect that the thresholds will halve to approximately $7 million per individual and $14 million per couple. Even if your estate is currently below these levels, this may not be the case decades from now when hopefully it will have grown substantially on a real, after-inflation, basis.
There are numerous strategies that one can use to lock in some or all of the current exemption limit including strategic gifting, charitable gifts, trusts, and other structures. Just as you have come to AlphaGlider for expert investment management and financial planning, we recommend that you work with an estate planning attorney for expert advice on estate planning. AlphaGlider does not provide legal or tax advice.
I Bonds
Back in July I recommended selling any I bonds you may have purchased in early 2001 and 2002 because their variable rate (based on short-term inflation) had fallen significantly, and because their fixed rates were set at 0%. I recommended reinvesting the proceeds into still safe, yet higher yielding instruments such as a high yield savings account, ultra short-term Treasuries (e.g. direct through treasurydirect.gov or via a fund like TBLL), or new I bonds which were sporting a 0.9% fixed rate at the time. But as of November and through April, the fixed rate component for newly issued I bonds was upgraded to 1.3%, the highest level since 2007.
Combined with its variable (inflation-based) rate, these I bonds currently pay out at a generous 5.27% annual rate for the first six months of ownership — at or above the rates for most other “safe” alternatives. Given their high fixed rate component which guarantees a long-term return safely above inflation and their tax benefits (no federal taxes due until sold, no state taxes ever), these I bonds are best held for the long-term (5+ years). If you want somewhere safe to park funds that you will likely need in the short-term, you still are probably better off in a high yield savings account or ultra short-term Treasuries as you have to surrender the last three months of interest if you sell an I bond before its fifth birthday.
Personally, I sold my early 2023 I bonds that I bought last January and purchased these new I bonds — raising the fixed rate component I received from 0.4% to 1.3%.
Two-Factor Authentication
On January 9, the Security and Exchange Commission (SEC) announced on X (formerly Twitter) that regulators had finally approved Bitcoin exchange-traded funds (ETFs).
2
The price of Bitcoin and the share price of Coinbase, the main crypto exchange, immediately spiked on the news. Thing was, the SEC actually had not yet approved the ETFs. That would not happen until the following day. Turns out, the SEC’s X account had been hacked.
The SEC made it easy for the hacker by failing to set up two-factor authentication (2FA) for the account. Take home message is to follow SEC Chair Gary Gensler’s words, and not his actions: set up 2FA to secure your financial accounts as well as to protect against identity theft and fraud.
If you have not already done so, please set up 2FA for your Schwab login (go to Profile/Security Settings/2-Step Verification), as well as any another other sensitive online accounts you have that support it (most do).
The most common method of 2FA is for the website to text you a one time password/code that you enter. However, this method is vulnerable to SIM-jacking — when the hacker effectively takes control of your phone number. An easy and effective way to stop SIM-jacking is to set up a pin number for the SIM card or eSim on your phone. Here are instructions on how to set up a pin number for your phone’s SIM: iOS // Android. Note that you will need to enter this pin number every time you reboot your phone.
An important first step to growing your net worth is to not lose it in the first place. Along with using a password manager, 2FA and locking your SIM are important methods to keep the bad guys from robbing you.
Tax Forms
It is mid-January, so it will not be long before tax preparation season is upon us. Schwab has already generated 1099-R forms for those of you with IRA distributions, and is expected to complete most other 1099s throughout the month of February. Although you should get your 1099s in the mail, you can also pull them up in your Schwab online account (look under the “Statements” link near the top of the page). When your 1099s post to your Schwab online account, you should get an email notification from Schwab.
As your accounts were also held at TDAI for part of the year, you may also get 1099s under TDAI letterhead if there was tax-related activity during that time. They too will be posted in your Schwab account, so no need to check your old TDAI account.
If you have not yet created your Schwab login, please do so asap. Note that a couple with investment accounts in separate names (e.g. IRAs) will need separate Schwab logins. You can do this by going to the Schwab login page and then clicking the “New user? link.” Once a couple has separate logins, each partner can approve view-only access to their Schwab investment account to their partner.
Schwab Monthly Statements in AlphaGlider Planning
You already go to the document vault in your
AlphaGlider Planning account
for your quarterly AlphaGlider statements. With you switch over from TDAI to Schwab as our independent custodian, you can now find your monthly Schwab statements there too. Naturally, these Schwab statements will also still be available in your
Schwab online account
(like with your 1099s, look under the “Statements” link near the top of the page).
**NOTES & DISCLOSURES**
1This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
2Mutual funds, exchange-traded funds and exchange-traded notes are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained directly from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
3Alternative investments, including hedge funds, commodities and managed futures involve a high degree of risk, often engage in leveraging and other speculative investments practices that may increase risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are subject to the same regulatory requirements as mutual funds, often charge higher fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. The performance of alternative investments including hedge funds and managed futures can be volatile. Often, hedge funds or managed futures account managers have total trading authority over their funds or accounts; the use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. There is often no secondary market for an investor’s interest in alternative investments, including hedge funds and managed futures and none is expected to develop. There may be restrictions on transferring interests in any alternative investment. Alternative investment products including hedge funds and managed futures often execute a substantial portion of their trades on non-US exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in the US markets. Additionally, alternative investments including hedge funds and managed futures often entail commodity trading which can involve substantial risk of loss.
4Rebalancing can entail transaction costs and tax consequences that should be considered when determining a rebalancing strategy.
^Indices are unmanaged and investors cannot invest directly in an index. The performance of indices do not account for any fees, commissions or other expenses that would be incurred.
aThe Standard & Poor's 500 (S&P 500) Index is a free float-adjusted market capitalization weighted index that is designed to measure large cap US equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization in the US equity markets.
bMSCI Europe, Australasia and Far East (EAFE) Index is a free float-adjusted market capitalization weighted index that is designed to measure the investable universe of developed market equities outside of the US.
cMSCI Emerging Markets (EM) Index is a free float-adjusted market capitalization weighted index that is designed to measure large and mid-cap equity market performance in the global Emerging Markets.
dMSCI All-Country World (ACWI) Investable Market Index (IMI) is a free float-adjusted market capitalization weighted index that is designed to measure the investable universe of global equity markets.
eThe Bloomberg Barclays US Aggregate Bond Index is a market capitalization weighted index that is designed to track most investment grade bonds traded in the United States. The index includes Treasury securities, government agency bonds, mortgage-backed bonds, corporate bonds and a small amount of foreign bonds traded in the United States. Municipal bonds and Treasury Inflation-Protected Securities (TIPS) are excluded due to tax treatment issues.
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