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Don’t Let Inflation Scare You Out of Stocks

As Miles discussed in this month’s Investment Comments, inflation has reared its ugly head for the first time in many years. For those of us that remember the 1970s “stagflation,” a combination of persistently high inflation paired with slow economic growth, just the word “inflation” brings to mind poor stock returns. Let’s delve a bit deeper into the damage inflation causes, why it has spiked, the prospects for the spike to continue, and our thoughts on what you should do with your portfolio, particularly your stock allocation.

Why is Inflation a Problem?

Rising inflation causes problems for everyone. For consumers, the ability to purchase goods and services is reduced as the currency they hold is no longer worth what it was in the past. Businesses endure two negatives: revenue can be suppressed as consumers can’t buy as much as they could before, and input costs are now higher, hurting profits. The overall economy slows until everyone has adjusted to the new price levels. If inflation is persistent these impacts are reinforced as workers demand higher wages to offset the reduction in purchasing power and business profits take a further hit from the higher wage cost. In the 1970s persistent inflation, exacerbated by higher energy input costs from two oil shocks, created stagflation as the economy never got a chance to fully adjust.

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August Investment Comments

The economic recovery continues, but the pace of the recovery is slowing. First quarter GDP was estimated at $22.1 trillion annualized, surpassing its pre-pandemic high of $21.7 trillion. Reclaiming our economy’s full potential might take a long time, however. GDP has rebounded sharply but remains approximately 2% below its pre-pandemic growth path. Gains have not been distributed equally, and inflation is squeezing the budgets of consumers left behind by the post-COVID recovery so far. Where we go from here is a bit of a mystery.

Employment statistics have recently plateaued at a level that would have been considered very unsatisfactory before the pandemic. June’s Bureau of Labor Statistics report showed the unemployment rate ticked slightly higher versus May at 5.9%, with labor force participation also about flat at 61.6%. Before the pandemic, unemployment averaged about 4% and participation about 63%. Wages were a bright spot in June, up 1%. Those who remain engaged in the workforce are being rewarded with paychecks growing faster than the cost of living, which is also increasing at a rate that would have caused major alarm before the pandemic.

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How to Make the Most of an Inheritance

It is estimated that over the next two decades, Baby Boomers will pass down a whopping $68 trillion worth of assets to younger generations. Receiving an inheritance should be considered a blessing, but if not handled correctly it can quickly become a curse. If you’re not careful, you run the risk of losing your money just as quickly as you receive it. According to a study conducted by the Bureau of Labor Statistics, one-third of people who receive an inheritance spend all of it in the first two years. With some sensible planning and foresight, you can make sure that your inheritance takes care of you and your family long after you receive it.

Here are some ideas to help set you on the right course with your newfound wealth.

First, take time to grieve and don’t make decisions right away. When you lose a loved one, you’re not thinking clearly enough to make sound financial decisions. Deciding what to do with an inheritance during this period can be overwhelming, upsetting, and cause confusion. There is nothing wrong with letting your inheritance sit for a while until you are ready to focus and develop a plan.

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July Investment Comments

The economy continues to improve, helped by the rollout of vaccines as well as fiscal and monetary support. Unlike typical recessions, this one was not born of financial factors but rather was the result of what was effectively a natural disaster. Economic activity was interrupted but much of the underlying demand for goods and services remained essentially intact. As highlighted in last month’s Investment Comments, the unique nature of this economic slowdown, and subsequent rebound, make parsing the data particularly difficult. When pandemic restrictions initially hit the economy, there were concerns it would take years for workers and businesses to heal. However, in the current quarter the size of the economy is now anticipated to surpass pre-pandemic levels and by year end GDP is expected to achieve its pre-pandemic path, if not exceed it.

According to the CDC, nearly 65% of U.S. adults have received at least one vaccination, and state and local governments continue to ease restrictions on businesses. Consumer balance sheets remain in good shape, aided by stimulus payments. Given a strong start to 2021, the National Retail Federation recently revised higher its expectation for retail sales this year, now anticipating an increase of 10.5%-13.5% versus its February forecast of 6.5%-8.2% growth. As consumers venture out categories such as beauty products have done well, as has spending on restaurants, lodging, and airlines. The Census Bureau announced May retail sales below expectations, down 1.3% from April, but up 24.4% versus a year ago.

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Schwab Transition: A Look Behind the Scenes

Work continues in earnest on the transition to Schwab. There is a lot of preparation that goes into changing custodians. This is often referred to as “repapering” in the industry, as every account requires new paperwork. There is the logistical challenge of gathering information for each client and each account in a practical format. There is the professional challenge of interacting with a new customer service team and a new software interface. Most importantly, there is the challenge of providing consistent service to clients and making the process as seamless as possible.

I will not rehash our explanations for making the transition, but I will give you an update on where it stands and why we have been asking you to confirm personal details that may seem trivial or unrelated to investment strategy. Our goal remains to complete the process mostly digitally. Our clients have been willing and helpful participants to that end. We plan to continue utilizing digital forms and signatures in our normal course of business, when possible. Reducing analog paperwork between you and your custodian should improve speed and efficiency.

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June Investment Comments

President Biden is negotiating for a $2+ trillion spending bill centered around infrastructure. It is hard to argue with infrastructure, which explains why that word features so prominently in the bill’s marketing push. The positive economic value from infrastructure improvements may be diminished by the potential chilling effects of tax increases to pay for the bill. Investors should keep a close eye on the risk of higher corporate taxes. The market responded robustly to the tax cuts that were implemented four years ago, and from the market’s perspective it is very hard to find a silver lining in the prospect of a rollback.

Wouldn’t it be nice to get the benefits of more spending without the cost of higher taxes? The difference between outlays and tax collections is the deficit, and the government’s ability to run expanding deficits depends on its borrowing rate staying low. Bond owners have not been very demanding in recent years, but their continuing good nature is forever being tested. In early May Treasury Secretary Janet Yellen admitted that the improving economy, boosted further by a large infrastructure bill, could necessitate higher interest rates. This sounds to us like basic common sense, or maybe Macroeconomics 101, but it stirred up quite a controversy. Investors are very sensitive about interest rates, inflation, and asset prices, and the Secretary’s remarks touched off a modest stock market decline that was stemmed by Yellen quickly “clarifying” her comments, saying she was not predicting higher rates. She was only speaking hypothetically.

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Celebrating Our 40th Anniversary

It is said that 70%-90% of new businesses fail within a decade. Imagine our pride that the little investment business founded by Ralph Seger and Maury Elvekrog on July 29, 1981 will soon celebrate its 40th anniversary!

Allow me to share a trip down memory lane, 40 years of history in a 10-minute read. After successful careers as a chemical engineer and industrial psychologist, respectively, Ralph Seger and Maury Elvekrog took their hobby of stock investing to the next level. Both began working for a local investment firm and quickly realized their investment philosophy and client focus were more aligned with each other than with their employer. Seger-Elvekrog Inc. soon followed.

Imagine the boldness to start a new investment business in 1981 in the midst of back-to-back recessions and bear markets! In retrospect, it was a wonderful time, as the United States was on the cusp of a long bull market lasting almost two decades with only brief interruptions.

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May Investment Comments

In the first quarter the S&P 500 returned more than 6%, a respectable start building on last year’s impressive gains. All eyes remain focused on the vaccine rollout and how quickly the economy can reopen more fully. Uncertainty persists regarding the course of the pandemic given the emergence of more contagious strains of the virus, but happily trends are in the right direction. The U.S. is on track to vaccinate three-fourths of the population by late June, though achieving that number requires overcoming vaccine hesitancy. However, much of the world is further behind, with emerging-market countries on pace to have closer to 30% of their population vaccinated by year end. Regardless, vaccine progress continues and should serve as a strong tailwind through 2021.

Helped by vaccines and trillions of dollars in government support, expectations for growth have been improving. The International Monetary Fund (IMF) recently bumped its forecast for world economic growth this year to 6% from prior estimates of 5.5%. This would represent the fastest expansion in at least four decades. Closer to home, the IMF estimates U.S. growth at 6.4%, fully recovering last year’s 3.5% contraction and then some. Economists surveyed by The Wall Street Journal anticipate momentum will continue into 2022 but slow to just over 3% growth. This would mark the strongest two-year growth in the U.S. since 2005.

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Bubble Fatigue

“People say that life is short, but it isn’t short. It’s very long.”

-Frank Abagnale

The battle cry of the modern speculator is “YOLO” meaning You Only Live Once. It is a kind of greedy twist on the “Carpe Diem” motto that Robin Williams invoked to motivate lackadaisical adolescent boys in Dead Poets Society. YOLO is obsessed with money—grab it all now before you die. People don’t yell “YOLO” when they give money to a charity or finish a challenging book. They could, but they don’t. They yell YOLO when they sink their annual bonus into cryptocurrency, or maybe when their broker approves a margin loan application. This greed is combined with a sort of nihilism—who cares if things don’t turn out how you’re hoping? In their view, living is doing outrageous things for a slim chance at a miraculous payday. I wonder what everybody will be yelling when it stops working?

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April Investment Comments

Government intervention has made it more difficult to read and predict economic tea leaves. Record low interest rates not only allowed homeowners to refinance their mortgages, but companies also refinanced their debt and increased their borrowings. This extended into “junk bonds” where yields edged below 4% before rising recently. Such a rate used to be reserved for only the most creditworthy companies, which were recently able to borrow for less than 1% on a short-term basis and less than 2% on a long-term basis.

Statistics for unemployment, retail sales, and personal income must now be interpreted in the context of stimulus payments and COVID-related restrictions on businesses. Retail sales fell a stunning 3% in the month of February compared to January. However, January was up 7.6% from December on a seasonally-adjusted basis that takes into account normal patterns like holiday spending. Government statisticians struggled to keep up, as the January surge was originally reported as a 5.3% gain.

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March Investment Comments

It is quite clear that as COVID-19 goes, so goes economic activity, which leads political response and tests the remarkable ability of people to adapt.

The path of the virus over the past few months is evident when examining what is surprisingly fairly solid economic data. Fourth quarter GDP grew 4%, capping a year that saw GDP fall 3.5% as large sectors of the economy, particularly travel and hospitality, were off limits to consumers. After COVID-19 case counts declined during the summer, a resurgence of the virus in the late fall and through the holidays spurred the reimposition of stay-at-home orders and retail closures for restaurants, gyms, and other gathering places. With less opportunity to move about, consumers still boosted their spending a respectable 2.5%, but this was short of what economists expected during the critical holiday season.

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Stick to the Plan

2020 was a very strange year for markets. Over the past year we likely set a record for the use of the word “unprecedented” on earnings calls. I suppose a pandemic combined with meaningful amounts of global monetary and fiscal support will do that. Going into 2020 analysts expected 5% revenue growth and 9% EPS growth, leading to an approximate 5% increase in the S&P 500. This was not particularly noteworthy, as the default estimate for growth in the S&P every year is a mid- to high-single-digit percentage gain. Though the final numbers for 2020 have yet to be counted, expectations are for a 1% revenue decline accompanied by a 13% drop in EPS, well below initial expectations. Meanwhile, the S&P 500 advanced by a better-than-expected mid-teens percentage. This goes to show the extreme difficulty in making forecasts, yet Wall Street continues to try.

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February Investment Comments

In 2020 governments around the world responded to COVID-induced economic shock with fiscal rescue policies that injected trillions of dollars into their economies and added similar amounts to sovereign debts. The Department of the Treasury’s Data Lab (datalab.usaspending.gov) recently estimated the total bill for U.S. fiscal relief at $2.6 trillion of stimulus plus $900 billion of tax relief, for a total of $3.5 trillion. That total grows closer to $4 trillion including the stimulus that President Trump signed in December.

On January 5, a surprise result in the Georgia Senate runoff turned what initially looked like a mixed U.S. election result into a “blue wave.” With a willing Congress behind him, President-Elect Joe Biden has promised to make more fiscal stimulus his top priority, proposing a $3 trillion stimulus and infrastructure plan.

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Trends Accelerating the Appeal of Roth Savings

Happy New Year! If you are like me, I bet you are glad to wave the year 2020 goodbye as it has been one of the saddest and strangest of times for our country. If you have lost a loved one or friend to COVID-19, please accept my condolences. Let us all wish for a speedy rollout of vaccines that bring this pandemic to a swift close.

As for the economy and investing, COVID-19 caused both predictable and surprising impacts. On the predictable side entire sectors of our economy, particularly hospitality and travel, fell into deep recession and will likely not reach 2019’s level of activity for years. Social distanc­ing accelerated trends that were already in evidence such as buying online, remote work, and entertainment on demand via streaming. Shutting down the economy to fight the virus led to recession and a bear-market drop that registered more than 40%, ending the longest bull-market in history at eleven years.

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January Investment Comments

As we wrap up 2020 it is worth highlighting what a roller coaster year it was for the market. Midway through December the S&P 500 has advanced more than 13%, a result that ap­peared highly unlikely during late March when shares fell sharply on COVID-19 fears. However, the market is forward-looking and global support in the form of fiscal and monetary stimulus has helped drive markets higher since the spring. Currently, the prospect of further stimulus combined with the fastest development of a vaccine ever recorded has boosted investor optimism and provided hope that a return to a more normal environment is on the horizon.

While several vaccines are on the way, the U.K. was the first country to authorize the Pfizer-BioNTech COVID-19 vaccine, starting distribu­tion on December 8th. U.S. health regulators authorized use of the same drug on December 11th with the first vaccinations taking place December 14th. Initial supplies of the vaccine are limited, but production is expected to increase meaningfully over the next several weeks. Pfizer shipped out three million doses initially with an expectation of 25 million doses available in the U.S. by yearend. Health workers are first in line for vaccinations followed by other higher-risk populations. Americans are expected to broadly be able to get the vaccine by the end of March

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Year-end Checklist

2020 will be remembered as a year like no other. A year that started out with a global pandemic and ended with a presidential election. A year that saw the stock market contract to bear market levels from record highs, only to rebound and set new record highs. However, with all the unexpected changes around us, one important task remains constant, year-end financial planning. As always this will help you better organize your financial health and start off the New Year on the right foot. Here are some key topics to consider addressing.

Gifting strategies

Whether you give to a loved one or to a charitable organization that is close to your heart, ‘tis the season of giving gifts. If you choose to give a gift to an individual, keep in mind that gifts up to $15,000 per person are allowed under the annual gift tax exclusion. Consider gifting assets that have the greatest potential for appreciation in order to optimize the tax savings.

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December Investment Comments

The election season is almost over, with a few disputes remaining to be resolved along with several incomplete congressional elections. Control of the Senate is up in the air, with 50 Republicans and 48 Democrats seated and two runoff races in Georgia set for early January.

Voters opted for divided rule. Democrats picked up the White House and at least one Senate seat, and retained control over the House. Republicans added one governorship and several state legislatures, sharply narrowed Democrats’ majority in the House, and likely retained a slim majority in the Senate. Neither party has run the table; both parties will have to work together to accomplish anything. This setup increases the odds of cooperation, moderation, and stability, a rarity in these partisan times.

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Provident Technology

From time to time, I like to update clients as to what is happening behind the scenes here at Provident. We’ve made a number of technology changes over the past year or so, and you might find it interesting to learn how things gradually evolve here. We are not “early adopters” of technology. We tend to wait a bit and let others work out the kinks on brand new offerings.

The impetus for this piece is an important change to our client accounting system. After almost 22 years with PortfolioCenter, we are switching to Tamarac Reporting. Portfolio­Center was a reliable software package, but began to show its age in recent years as owner Charles Schwab Corp. seemed to stop investing in it.

About two years ago, Schwab sold the Port­folioCenter business to Envest­net/Tamarac, a publicly-traded software company focused on the investment industry. The buyer had been using PortfolioCenter as the backbone of its own online portfolio accounting soft­ware, and was the logical buyer when Schwab wanted to exit that business.

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November Investment Comments

We have a long way to go, but so far the post-COVID economy looks surprisingly robust. If colder weather does not bring a resurgence of the virus, then it feels safe to say that we are firmly on the road to economic recovery.

From peak to trough, U.S. GDP contracted by 10%, the third largest decline since at least 1910. The second-quarter average was -9%. More recently, September’s unemployment report published by the Bureau of Labor Statistics measured unemployment at 7.9%, down from a peak of 14.7% in April. This probably overstates the rebound slightly, as the labor force participation rate ticked down to 61.4% and is about 2% below its pre-pandemic levels. Some workers have stayed on the sidelines and aren’t counted as unemployed.

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Instrument Flying

To say this has been an interesting year for the market would be an understatement. After the swoon in March due to the pandemic, we recovered the entirety of the downturn and then some. There have been only a few market declines of similar magnitude over such a short timeframe, and the abruptness of the snapback has surprised many, especially given what are likely to be longer-lasting effects on the economy from COVID-19. To be certain, fiscal and monetary stimulus have played a significant role in supporting the economy and aiding the market’s recovery. Interest rates have declined, helping make the case for higher P/E multiples. Lower interest rates reduce the rate at which future cash flows are discounted, raising asset prices in general. However, while a portion of the recent rebound in stock prices looks to be justified, it has been accompanied by some harder-to-explain moves in certain individual stocks, and for that matter certain other assets.

Though more traditionally discussed in relation to bonds, the concept of “duration” similarly applies to stocks. Duration is a measure of the weighted average of when investors receive their cash flows. Though the risk profiles generally differ, stocks and bonds are fundamentally similar. Each produces a stream of cash flows; however, unlike bonds, which have contracted payments over preset intervals, the “payment” on stocks is less certain. Assets that are longer duration are more sensitive to movements in interest rates, deriving greater benefit from lower rates and alternatively selling off more when rates rise. Stocks generally have a longer duration than bonds, and among stocks durations will differ as a result of the anticipated cash flows.

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