May 2022 Newsletter

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

Summary

Since the January 3 S&P 500 Index all-time closing high, the market has been in an aggressive downward spiral. As of the close on April 29, the S&P 500 index has dropped 13.9% from its high. We are in a typical market correction due to two phenomena – the recent high market valuations in 2021 were unsustainable and the pending monetary policy changes of higher interest rates to fight high inflation.

Timewise, we believe this correction is in the 6th or 7th inning. Likely this market will continue to drop by another 3% to 6% over the next two to four months. This is not a time for long-term investors to panic! If we are able to determine a buying opportunity in the near term, we will announce it. Everyone should mentally prepare themselves to be ready to “buy” into this low market. Buying low is a good thing – it just takes courage and patience.

On the good side, the U.S. economy (different than the stock market) is in good shape with corporate earnings in the first quarter exceeding expectations. Our economy also has strong employment and rising wages. In the meantime, the three largest economies in the world are all showing signs of anxiety.

High inflation in the United States is being fought by increasing interest rates with the expectation that high interest rates will eventually reduce consumer demand, and that will in turn reduce inflation.

China’s gross domestic product is losing ground as the Communist government is fighting COVID by locking down whole cities instead of buying effective COVID vaccines from Moderna and Pfizer.

The European economy and the supply of gas to heat homes and businesses next winter is threatened by Russia and its war with Ukraine.

Goldman Sachs rates the risk of a recession at 30% in the U.S. within the next 24 months.

Quote of the Day

Dan Parker and his specially modified Corvette

Pop Quiz

Last month we challenged our readers to broadly understand the quantities of refined products that come from a barrel of crude oil. This month we want to focus on just “diesel fuel.” An 18-wheel semi-tractor and trailer typically weighs 35,000 pounds empty, and 80,000 pounds fully loaded. Therefore, a semi’s freight can weigh as much as 22.5 tons. A typical semi-tractor trailer can move 1 ton of freight 134 miles on a single gallon of diesel fuel. How many miles can a freight train move 1 ton of freight per gallon of diesel?

125 miles?

250 miles?

500 miles?

750 miles?

The answer is at the bottom of the newsletter.

The Economy

Unemployment Rates by Education Level, March 2022

Average weekly earnings of all employees on private nonfarm payrolls were up 4.7% compared to a year ago.

Gross Domestic Product (GDP)

The Bureau of Economic Analysis said the first estimate for the 2022 first quarter GDP decreased by 1.4% compared to a 6.9% increase for the fourth quarter 2021.

 

The primary reason for the negative GDP real growth in the first quarter was a decrease in U.S. exports and a large increase in imports. Both actions are reductions in the GDP calculation.

Inflation

Annual inflation rose 6.6% in March as measured by the Personal Consumption Expenditures (PCE) index. The core PCE index, which excludes food and energy, rose only 5.2% in March, as compared to the adjusted 5.3% in February.

Fortunately, we all do not live in Big Sur, California. Here is a snapshot of gas prices in Big Sur on April 3, 2022.

This month’s estimated annual inflation numbers above are 3 basis points higher on average compared to last month.

Important Dates in May

May 1 – In 1889, comrades within the International Socialist Conference declared, “May 1 will be the international holiday for labor!” Well not quite.

May 3 – Primary election day in Indiana and elsewhere.

May 3 & 4 – The third Federal Open Market Meeting of 2022.

May 4 – May the fourth be with you.

May 5 – Cinco de Mayo, in the United States, this date has evolved into a commemoration of Mexican culture and heritage.

May 7 – The Kentucky Derby.

May 8 – Mother’s Day.

May 8, 1945 – VE Day or WWII’s Victory in Europe Day.

May 21 – Armed Forces Day.

May 29 – The Indianapolis 500.

May 30 – Memorial Day. This day was originally called Decoration Day. After the Civil War, this day was set aside for family members and the public to decorate the graves of the soldiers who died in that war. After World War I, the holiday was expanded to honor all American war fatalities. The name Memorial Day became more commonplace after World War II.

Stock Market

Commentary

Jonathan Krinsky

Jonathan Krinsky, BTIG Chief Market Technician, said on April 30 on CNBC, “The S&P 500 Index needs to break below the 4000 level. We believe we need to get to a point of indiscriminate selling. We are almost there but not quite. This is how a market correction unfolds.”

Stock Market Valuations

Our current 2022 year-end prediction for the S&P 500 Index profitability is $225 per share. Our best optimist estimate for the year end PE ratio is 21. If so, we will see the following:

Remember, the market all-time closing high was 4,796.56 on January 3, 2022. But this market is going down. Just how low could we go yet this year?

The current Lorenz Financial prediction for the S&P 500 Index bottom in the short-term is 3900 +/- 100.

Recent Monthly Performance of the S&P 500 Index

Is This an Average Correction?

Sam Stovall, Chief Investment Strategist at CFRA Research, told CNBC, “Since 1945, we have had 23 market corrections with downturns of -10% to -19.9%. The average drop was 14% and the timeframe from peak to trough was 4 months.” So far this is an average correction. But we have begun an increasing interest rate cycle, along with significant supply chain disruptions and a war in Ukraine. For these reasons we believe the downturn of this stock market will continue to get worst and potentially hit bottom at -18% to -20%.

Recommended Action for Your Stock Portfolio

Last month we listed three types of securities to avoid. Those are stocks of unprofitable companies, stocks of Chinese companies, and bonds.

Last month we listed three types of securities to avoid. Those are stocks of unprofitable companies, stocks of Chinese companies, and bonds.

From a financial point of view, COVID brought us massive and predictable liquidity (money) injections into the economy by both Congress with their fiscal policy and the Federal Reserve with their monetary policy. Many assets have benefited from the resulting increase in the money supply – namely real estate, stocks, and crypto assets.

But now all of this easy money is being taken away to fight inflation. The asset prices that have benefited the most from the injection of money into our economy will likely suffer the most as the liquidity is taken away. We believe four things:

1. The least dirty shirt in the closet is stocks.

2. The type of stocks that will do the best are stocks, exchange traded funds and mutual funds with a focus on “value” companies, not growth companies. Value means stocks of companies with stable profits, safe dividends, a strong balance sheet and most importantly, a value company’s products and services having demonstrated a strong preference by customers. In alphabetical order some value company examples are, but not limited to, AbbVie Inc., Apple, Bank of America, Berkshire Hathaway, Chevron, Coca-Cola, DOW Inc., Home Depot, Honeywell, JPMorgan, Microsoft, and United Healthcare. We are not recommending individual stocks as an investment but instead investors should seek out ETFs and mutual funds that contain these types of companies.

3. During 2022, an investor’s safe money cannot hide in bonds – for now use cash.

4. The asset category that will likely be hurt the most is crypto.

In January 2022, we briefly described Exchange Traded Notes (ETNs), and recommended investors stay away from them. We believe ETNs are very inappropriate for the typical investor, and we want to re-emphasize in detail the dangers of ETN’s this month.

Exchange Traded Notes are wolves in sheep clothing. They sound like a close cousin of mild-mannered Exchange Traded Funds (ETFs), but they are not. ETFs primarily invests in a variety of stock indexes.

But ETNs are an unsecured debt instrument issued by a bank that earns no interest, pays no dividends, and has no FDIC, government, or bank guarantee. Instead, the value of the ETN moves up and down on a daily basis as it tracks a specific asset such as a commodity, currency, or an index of volatility. Some ETNs are reverse engineered meaning if the price of the underlying asset goes up, the value of the ETN goes down. Other ETNs are leveraged meaning if the underlying asset goes up or down 1%, the ETN goes up or down 2 or 3%. Speaking with a sarcastic voice, Lorenz Financial says, “Well, that sounds safe enough!”

The annual expense ratio of an ETN is typically 0.75% to 1.0%. That is good news for the issuing bank. On the other hand, an inexpensive Exchange Traded Fund is the Total Stock Market Index, symbol VTI. VTI’s annual expense ratio is only 0.03% per year.

One Wall Streeter said, “ETNs are the sharpest knife in the drawer – suitable only for the most sophisticated investor.” We agree. ETNs represent an asset class that is expensive, risky, volatile, and complex. Lorenz Financial believes all investors should stay far away from ETNs.

OK, Now What Do I Do? 

With the market down, this is an excellent time to regroup; so, let’s identify some successful long-term financial guidelines.

1. Spend less than you make. It doesn’t matter if you make $30,000 a year or $300,000 a year, you must spend less than you make.

2. If your employer offers a retirement plan, contribute enough to capture all of the dollar matching from the employer. Its free money! With the stock market down, buying low is a good thing!

3. Build up your individual or family emergency fund. Dave Ramsey says to start off with $1,000 in a savings, checking or money market account that can be accessed immediately.

4. Maintain adequate insurance to avoid a family financial crisis. Required insurance includes: Home or renters, Medical, Auto, Term Life (if you have dependents), Umbrella Liability, Personal ID Theft, Around the age of 55 to 60, purchase Long Term Care Insurance

5. Eliminate all bad debt. All debt is bad debt except a fixed-rate first mortgage on your home.

6. Increase your emergency fund to six to nine months of family expenses.

7. Save for a 20% down payment on a home. With 20% down, the home buyer will avoid being forced to buy Private Mortgage Insurance (PMI). PMI is a substantial monthly addition to the mortgage payment. The home buyer’s monthly mortgage payment of principal, interest, taxes, and insurance should not exceed 25% of the family’s take-home pay.

8. Whenever a family member gets a pay raise, save 50% of the raise by increasing the amount saved and invested each month. The goal is to save and invest 15% of total income for retirement.

9. Even if you manage your own investments, get a financial plan from a Registered Investment Advisor to insure you are saving enough, not spending too much, and on track for a great retirement.

Our Bad Boy This Month

Too Many State & Local Building Codes Enable Homes to be More Flammable than Trees

Source: The Wall Street Journal, April 15, 2022, page A3

This picture is of a home that was destroyed during April as part of the McBride fire in New Mexico. How is it possible that this home, and many like it, can burn to the ground during a forest fire but the ruins are surrounded by green, unburned trees!

It seem illogical that building codes in the 21st century allow homes and commercial buildings to be more flammable than the trees, but this picture, and many others like it, says otherwise.

Indiana and Kentucky Cut Their State Income Taxes!

Indiana Governor Eric Holcomb signed a bill on March 16 that was passed by the Indiana House and Senate that cuts the state’s personal income tax rate from 3.23% in 2022 to 3.15% in 2023. The rate could drop all the way to 2.9% in 2029 so long as the state’s revenue continues to increase by 2% a year.

Also, in April the Kentucky House and Senate voted to override the veto of Democratic Governor Andy Beshear of a bill that reduces the state’s personal income tax rate to 4.5% from 5% in 2023. Additional 0.5% cuts are outlined in the bill each year if the state reserves hold up and revenues exceed spending.

Bond Market

Commentary

In the past year we have warned readers that bond prices fall when interest rates increase. Well, here is the proof. Below we have listed five different Fidelity bond funds with varying duration. Duration is the average number of years for bonds in a mutual fund to mature. The lesson here is, the longer the duration, the faster bond fund prices drop as interest rates increase.

And the Federal Reserve has just started increasing interest rates. The funds’ year-to-date performance above is as of the close of business on April 29, 2022.

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

The next FOMC meeting is May 3 – 4. We expect a 50-basis point rate increase in the federal funds rate at that meeting. We also expect the FOMC to announce their plans to begin to shrink their balance sheet by selling bonds at a rate of $50 billion to $95 billion a month.

But everyone must realize the paradigm has changed! The goal posts have moved! For 39 years we have been in an era of decreasing interest rates. See the chart below of the 30-year U.S. Treasury from 1977 to present. Note the U.S. Treasury suspended issuance of the 30-year bond from February 2002 to February 2006.

Another way to describe the bond market for the previous 39 years is, “the bond market had been in a bull (good) market from September 1981 to April 2020 because as interest rates declined existing bond prices increased.” But now interest rates are headed up causing existing bond prices to drop.

The U.S. Treasury

The Secretary of the Treasury, Janet Yellen, is the Chair of the Board of Trustees for the Social Security and the Medicare Trust funds. A brief summary of the Trust fund’s 2021 report follows:

“The Old-Age and Survivors Insurance (OASI) Trust Fund will be able to pay scheduled benefits on a timely basis until 2033. At that time the fund’s reserves will become depleted. Tax revenue will then only be able to pay 76% of benefits.

The Hospital Insurance Trust Fund of Medicare Part A will be able to pay scheduled benefits only until 2026.”

These reports are submitted annually to Congress but apparently these reports are not dire enough to cause action.

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 in 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

Broadly, we believe buying an individual bond or a bond fund right now (except Savings I-bonds) is like picking up a hornet’s nest. You will regret it.

Before Investing

Of course, everyone should maintain a safe and liquid emergency fund of at least 6 to 9 months of family expenses in an FDIC insured bank or an NCUA insured credit union. An emergency fund should be kept in a checking account, savings account, or money market account – it should not be “invested or tied up in any way”. Also, since rule one is: “Spend less than you make”, every family should strive to reduce debt to only having a fixed-rate first mortgage. All other debt is bad debt.

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS.

Pop Quiz Answer

A typical semi-tractor trailer can move 1 ton of freight 134 miles on a single gallon of diesel fuel. How many miles can a freight train move 1 ton of freight per gallon of diesel?

Answer: 500 miles