June 2022 Newsletter

Welcome to the June 2022 Newsletter. This month, we’re discussing the economy, employment, financial terminology, and more.

Summary

The extraordinary three-year stock market rally from 2019 through 2021 brought the cumulative Total Stock Market index return to the exceptional level of +98.9%, one of the greatest three-year returns in history. The market’s closing peak was on January 3, 2022, with the S&P 500 Index at 4796.56. The strength of that market unfortunately raised investor expectations to unrealistic levels.

Now, the turnaround has been dramatic as concerns have quickly developed around high inflation and the Federal Reserve announcement that interest rate hikes would begin in March. Then in late February, Russia invaded Ukraine and China started locking down cites due to COVID. The price of rent, food, and energy have since skyrocketed.

When will this end? Are we headed for a recession? Of course, no one knows. Below we discuss the S&P 500 Index bottom could be as low 3400 to 3500 later this year. But we also believe the Index will recover and reach 4800 to 5000 during the first half of 2023.

If the market develops a strong buy signal later this year, we will announce it as quickly as possible.

Quote of the Day

Warren Buffett

Pop Quiz

Which seven states have no income tax and which two states tax only interest and dividends?

The answer is at the bottom of the newsletter.

The Economy

Employment

Unemployment Rates by Education Level, March 2022

Average hourly earnings of all employees on private nonfarm payrolls were up 5.5% compared to a year ago.

Gross Domestic Product (GDP)

The Bureau of Economic Analysis said the second estimate for the 2022 first-quarter GDP decreased by 1.5% compared to a 6.9% increase for the fourth quarter 2021.

Annual inflation decreased to 6.3% in April as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, decreased for the second month in a row to 4.9% in April, as compared to the adjusted 5.2% in March and 5.3% in February.

Lorenz Financial focuses on the PCE inflation index instead of the CPI index as the PCE index is the favorite inflation index of the Federal Reserve.

The nation-wide median price of an existing home sold in March 2022 was 15.0% higher on average than March 2021 according to the National Association of Realtors. The median price was $375,300.

Long-term inflation expectations can be estimated by measuring the differences between Treasury bond yields & TIPS real yields of the same maturities. Results are:

This month’s estimated annual inflation numbers above are 24 basis points lower on average compared to last month.

Important Dates in June

June 3 – 4 – On this night in 1989 in Tiananmen Square, Beijing, the Chinese military sent in tanks and heavily armored troops to disperse thousands of protesters. Hundreds were killed, thousands wounded. Many college students were arrested and sent to prison. The Chinese Communist Party termed the event as “suppression of bourgeois liberalism.”

Tank Man – courage rises up when the need reaches desperation.

June 4 – National Hug Your Cat Day, until they smile!

Even a lioness can smile!

June 5, 1968 – Robert Kennedy was assassinated in Los Angeles shortly after winning the California presidential primary. He died the next day.

June 6, 1944 – D-Day was the largest amphibious invasion in military history. “Operation Overlord,” as it was officially called, combined the forces of 156,000 U.S., British, and Canadian troops, 7,000 ships & landing craft, and 2,400 aircraft & 850 gliders. The 9,387 Americans buried at Omaha Beach have ensured Americans today are speaking English and not German.

The American Cemetery at Omaha Beach, France. Just as the American Embassy in Paris is situated on U.S. government property, so is Omaha Beach.

June 10, 1963 – President Kennedy signed the Equal Pay Act.

June 11, 1963 – President Kennedy addressed the nation to explain the moral imperative behind the civil rights bill he planned to send to Congress.

June 14 – Flag Day. On this day in 1775, the Continental Congress united all the individual state military units under one command and thus gave birth to the Continental Army. Flag Day is the birthday of the U.S. Army. Its first Commanding General was, of course, George Washington.

June 14 – 15 – The fourth Federal Open Market Committee meeting of 2022.

June 19 – Father’s Day

June 21 – The first day of summer, the summer solstice, the longest day of the year

The Stock Market

Commentary

Jonathan Krinsky

We reported last month that Jonathan Krinsky, BTIG’s Chief Market Technician, said on April 30, “The S&P 500 Index needs to break below the 4,000 level.” Well, Jonathan was right—on May 9, the S&P 500 index closed at 3,991.

Now on May 25, Jonathan said on CNBC, “A short-term market call is very difficult. But clearly, we can make the case for a counter-trend rally (up rally), but that is a small part of the equation. Ultimately, we still see a significant move lower for both the S&P 500 and Nasdaq, with the S&P 500 reaching the 3400 to 3500 level.

“Our call a month ago for the S&P 500 Index to break through at 4,000 seemed like a logical point. We have had the market move down now for seven consecutive weeks. We have seen a lot of damage. It would make sense that we will now have a period of consolidation around S&P 500 4,000 as we move into the summer.

“We don’t think the market is going to go immediately down to 3,400 to 3,500. We could have a very short-term bounce to 4200 and then spend a few months this summer in and around the 4,000 level. But this does not change the primary downward trajectory of the market.

“So, where did we get the 3,400 to 3,500 range as the bottom? This was the market high before COVID in early 2020. We see that as a logical level of support.”

Stock Market Valuation

The all-time S&P 500 Index closing high was on January 3, 2022.

Yes, now we’re in a nauseating Bear (down) stock market. Possibly, where is the bottom?

The all-time average for the S&P 500 Index PE ratio is 16. Likely, we’re headed there or lower.

Our best case is

But the worst case might be

The S&P 500 Index closed at 4132.15 on May 31. The current Lorenz Financial prediction for the S&P 500 Index bottom for the remainder of this year is 3,450 +/- 100.

Monthly Performance of the S&P 500 Index

Recommended Action for Your Stock Portfolio

Everyone, please stay strong by drawing on your patience and courage. The stock market has never gone to zero; not during the Great Depression, not during the massive ’73 – ’74 recession, not during the Dot Com Bubble of 2000, not during the worldwide Financial Crisis (The Great Recession) of 2008 – 09, and not during COVID. Every time the market has recovered and made new highs.

So please continue to make your weekly, bi-weekly, or monthly contributions to your employer’s retirement plan or your IRAs. Buying low is a very good thing!

Let’s review the definitions of Price to Earnings (PE) Ratios and the Federal Reserve’s tools of changing the Federal Funds Rate and Quantitative Tightening and Easing.

PE Ratio

The PE Ratio of a stock or stock index is a number calculated by dividing a stock’s Price per Share by the stock’s Earnings per Share. A PE ratio is typically between 10 and 30, but can exist below 10 and over a 100. The PE ratio defines how much current buyers of a given stock are willing to pay for each dollar of corporate earnings.

For example, if a company has $2.00 of annual earnings and a stock price of $28 per share, its PE ratio is of course 14. This says current buyers of this stock are willing to pay $14 for every dollar of earnings of that company. If the company announces a fantastic new product with annual future company earnings increasing to $3.00 per share, the stock price could zoom to $42 per share ($3.00 X 14). But the good news might generate excitement for the company causing stock buyers to be willing to pay $18 per share for each dollar of earnings (PE Ratio of 18). If so, the stock price might go up to $54 a share ($3.00 X 18).

Stock indexes can also have a PE Ratio. As we have described above, the S&P 500 Index is projected to have $222 of earnings in 2022 (every stock analyst will have a slightly different number). At the all-time closing high on January 3, 2022, the index stood at 4796.56. This calculates to a PE Ratio of 21.6. Obviously since January 3, stock buyers are willing to pay less and less for each dollar of corporate earnings. Why? Three main reasons:

1. High inflation is causing the Federal Reserve to increase interest rates which might cause a recession.
2. The Russian war in Ukraine is removing at least 13% of the world’s food supply which has already begun to aggravate the price of food worldwide.
3. China continues to lock down major cities to fight COVID, which disrupts major supply chains around the world.

See the chart below of nearly 100 years of data of the S&P 500 Index PE Ratios.

PE Ratios from June 1928 to April 2022

Gray columns represent recessions

The vertical axis displays PE ratios on a logarithmic scale. The horizontal axis displays calendar years. The long-term average PE ratio of the S&P 500 Index is 16.

The Federal Reserve has two mandates: maximum employment with stable prices. Right now, employment opportunities are everywhere, but inflation is very high. So, what are the Federal Reserve’s tools to reduce inflation? They have two primary tools.

The Federal Funds Rate

This is the interest rate that depository institutions—banks, credit unions, and savings & loans—charge each other for overnight loans. These financial institutions must have a certain amount of cash on-hand in their vault or on deposit at the closest Federal Reserve Bank each night. If one bank makes a big loan to a customer, perhaps that bank will be short on their reserve requirement for that night. To avoid a penalty, the bank might borrow for the night from another bank that has excess reserves.

The interest rate the second bank charges the first bank is set by the Federal Reserve. This rate is called the Federal Funds rate. The Federal Funds rate is a very short-term interest rate, but it directly influences the interest rate paid by Treasury Bills whose maturity ranges from one month to one year.

Right now, the Fed wants to increase short term interest rates to slow down the economy and reduce inflation. Therefore, the Fed is raising the Federal Funds rate.

Quantitative Tightening or Easing

The host of a financial news TV program might say, “The Fed is decreasing (or increasing) its balance sheet with Quantitative Tightening (or Quantitative Easing).” When the Fed wants to reduce long-term interest rates, such as when COVID first hit in March 2020, it started buying long-term Treasury bonds and mortgage-backed securities. This presents an increase in demand for these bonds. As the demand goes up, the price of these bonds goes up. As the price goes up, the yield on these bonds goes down which is exactly what the Fed wanted. As the Fed bought bonds, the Fed’s balance sheet increased. Right now, it is approximately $8.5 trillion.

Now, the Fed wants to increase long-term interest rates to slow down the economy and reduce inflation. Therefore, the Fed will start selling their bonds in June 2022, increasing the supply of bonds, driving the price of bonds down and the yield of all bonds will increase.

As the Fed receives interest payments on the bonds in the Fed’s inventory, the Federal Reserve returns that income to the U.S. Treasury every quarter.

OK, Now What Do I Do?

Last month we talked about nine steps appropriate for all families to get their financial house in order.

Today’s stock market is not only down, but it’s likely to grow more slowly in the next 10 years than it has in the past decade. But on the positive side, there are things we can all do to protect ourselves and our retirement. So, here are some good ideas for a family’s action plan.

For Everyone

Don’t panic and don’t sell stocks at the bottom!

Make sure your family spending is less than your income. In fact, try to cut back on spending so you can save and invest a little more as stock market returns over the next 10 years are expected to be minimal.

For the family’s safe investments, don’t buy bonds or bond mutual funds until interest rates stabilize. Leave your safe money in cash. The Fed is only starting Quantitative Tightening in June.

Don’t look at your investments daily. Focus on your family and job.

If money is tight, psych yourself up and get a second job. Options include:

• Paper route in the early morning
• Deliver pizza in the evenings
• Become an Uber or Lyft driver part time
• Babysit for a friend or neighbor on a weekend. Babysitting rates have recently skyrocketed.

Does your family have any “non-performing assets?” A third car, but you only need two. A vacation house no one ever uses. If so, get the “For Sale” sign out.

Continue to invest only in registered securities and avoid unregistered securities such as crypto assets, NFTs, non-traded REITs, and stocks or bonds issued by a private company. There is a long list of investments to avoid. If an investor cannot distinguish between what to buy and what not to buy, seek out a Registered Investment Advisor, a fiduciary, to help you.

For Those Still in the Workforce

Don’t stop buying inside your employer’s retirement plan. In fact, try to increase the amount purchased each pay period. With the stock market down, investors are buying low. Buying low is a very good thing!

If the family’s emergency fund is a little short, begin to build it up to six to nine months of family spending in case layoffs begin.

If layoffs are in our future, impress your supervisor by exceeding his or her expectations daily! You will increase your odds of not being laid off.

Employ “tough love” appropriately. If money is tight, there should be no adult in your household that does not have a job except a new mother, a stay-at-home dad, or a disabled person. There are 11.5 million open jobs out there.

For Retirees

Lorenz Financial recommends, “take Social Security at age 70 or when you need it, whichever occurs first”. The minimum age to draw Social Security benefits is 62. For every year a retiree can delay taking Social Security, the benefits increase approximately 8% plus the rate of inflation.

If the family is withdrawing from investments during retirement, try to cut the amount withdrawn in half. Taking money out at the same time retirement account balances are dropping will significantly shorten the life of the account.

OUR FINANCIAL BAD BOY THIS MONTH

The Price of Non-Fungible Tokens Has Collapsed

Source: The Wall Street Journal, May 4, 2022, page B1

In our June 2021 newsletter, under the category, “Inappropriate Investments,” we listed SPACS, crypto assets, and non-fungible tokens (NFTs). In that newsletter we said, “A non-fungible token is a digital asset that represents a real-world object like art, music, or a video. NFTs are allegedly one of a kind. Because an NFT is a digital asset, the owner has a built-in authentication within the blockchain.”

The price of SPACS and crypto assets are not doing so well but the price of NFTs has totally collapsed. In March 2021, Jack Dorsey, then CEO of Twitter, sold his first tweet as an NFT for $2.9 million. The buyer was Sina Estavi, CEO of a blockchain company in Malaysia. Earlier this year, Mr. Estavi put his NFT up for sale in an auction but did not receive any bids over $14,000.

It looks like NFTs of the 2020 decade are nothing more than Beanie Babies of the 1990s or Cabbage Patch Dolls of the 1980s or Tulip Mania during the Dutch Republic of the 1600s – a collecting frenzy that quickly drives prices ridiculously high just before the bubble collapses.

ANOTHER FINANCIAL BAD BOY THIS MONTH

The Stable Coin, TerraUSD, Has Collapsed

Source: The Wall Street Journal, May 14 – 15, 2022, page B11

Gee, someone told me a crypto stable coin like TerraUSD could not lose money! Stable coins claim to fame has been they will maintain a value of $1.00 per coin. At one point, TerraUSD had $18 billion in deposits when it was worth $1 per coin. But, TerraUSD dropped to $0.017 per coin on May 31.

It’s important to note there are two types of crypto stable coins. One type is backed by assets, such as cash and Treasury Bonds, and the other type, such as TerraUSD, is backed by a mathematical algorithm that ties the stable coin to a standard crypto coin. In this case, TerraUSD was tied to Luna. On April 1, 2022, Luna opened for trading at $103.05. By May 17, it opened at $0.00019.

The Bond Market

Commentary

One of the most reliable yield curve recession indicators is the spread between the 10-year Treasury and the 3-month T-bill. This spread has turned negative before every recession over the past 50-plus years. Currently, this spread is 169 basis points, which is a healthy level, but we expect this to decline throughout the year as short-term rates will move higher. If the spread turns negative, a recession will likely follow. For now, an imminent recession is not on the horizon, but we see the risk of a recession increasing in 2023. Remember, whenever the next recession begins, the stock market will likely bottom six months prior.

The Federal Reserve and its Federal Open Market Committee (FOMC)

The FOMC met on May 3 & 4 and voted to raise the short-term Federal Funds rate by 0.50% to the current range of 0.75% to 1.00%. The Committee also voted to begin Quantitative Tightening in June 2022 by beginning to sell some of their bonds. From June through August, the selling target is $47.5 billion a month, and in September the target doubles to $95 billion a month. In September, the Federal Reserve will be selling $60 billion a month of U.S. Treasuries and $35 billion a month of mortgage-backed securities.

On May 12, the U.S. Senate voted 80-19 to confirm Federal Reserve Chairman Jay Powell for a second four-year term.

The U.S. Treasury

The U.S. annual budget deficit is dropping rapidly. Why? Tax receipts are rising at an astonishing rate. Federal receipts through April rose $843 billion, or 39%, from a year earlier. Most of the increase is due to individual income tax receipts increasing $698 billion thanks to economic growth and labor cost inflation that has boosted income.

Recommended Action for Your Bond Portfolio

There have been no changes to our bond fund recommendations this month. Most bonds are not appropriate today because it is expected that the short- to mid-term interest rates will rise above today’s levels. As bond yields increase, existing bond prices decline. Our bond market recommendations, in order, only include the following:

• Cash
• U.S. Savings I-Bonds
• Ultra-Short-Term U.S. bond funds

BEFORE INVESTING

Rule one is “spend less than you make.” Every family should strive to reduce debt to only a fixed-rate first mortgage and, eventually, no mortgage. All other debt is bad debt.

Rule two is “maintain a safe and liquid emergency fund of at least six to nine months of family expenses.” An emergency fund should be kept in an FDIC insured bank’s or NCUA insured credit union’s checking account, savings account, or money market account.

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS.

Pop Quiz Answer

Which seven states have no income tax and which two states tax only interest and dividends?

The seven states with no income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.

The two states that have no income tax, but do tax interest and dividends are New Hampshire and Tennessee.