Market Musings Blog

Silicon Valley Bank: Update!

Posted on 03.10.23 by Michelle Rand in Interest Rates, Investment, Personal Finance

We wrote this blog a few days ago, but already a lot has happened. SVB as everyone knows went into dissolution. Along with it went Signature Bank, and now First Republic has accepted capital infusions and loans to stay afloat. There will likely be others.

While SVB was dissolved, with its parts being sold off and the cash being used to cover deposits, the Fed also established a line of credit so banks could borrow against their securities to pay depositors even if those depositors had uninsured funds at SVB. The loans are good for one year. The funds do not come from taxpayers; they come from a fund established via the Dodd-Frank legislation, paid into by banks, to rescue their own. It’s a “bail-in” rather than a “bail-out”. Still, the money complicates the issue of inflation. Now that banks are failing, the Fed must inject money into the system that was previously NOT in the system, and while the loans do have to be paid back, there are questions about whether that can happen. Other questions include:

  • Will the “bail-in” funds be enough to cover all the non-insured depositors that might end up in trouble?
  • Which banks are next?
  • Will the funds have to be paid back if a recession hits, and banks’ results are depressed anyway because of that?
  • Where does the backstop of depositors stop?
  • Why do we have deposit insurance limits if we are going to rescue depositors anyway?
  • What happens to the Fed’s inflation-fighting interest rate path now?

We should know the answers to a couple of these questions in a few weeks. In the meantime, be sure your bank deposits are close to or below the insured limit, on the theory that it’s better to be safe than sorry. Funds can be stashed in brokerage money market funds, used to buy Treasury bills, or scattered among several banks.

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Over the last two days, Silicon Valley Bank experienced steep withdrawals and booked losses on securities it had to sell, resulting in a takeover by its regulator, the FDIC. Registering as the 18th largest bank in the US and the second largest bank failure ever, SVB largely provided services to startup technology companies. Those companies deposited a lot of cash – a good thing – but SVB used the money to buy Treasury securities which are now at steep losses thanks to higher interest rates.

When the bank needed to pay higher interest rates to depositors to keep them from moving their deposits to higher-rate alternatives, it sold some of those securities at a loss to raise the cash to do so. That, in turn, spooked the market, leaving SVB bereft of cash.

Many other bank stocks reacted negatively to this event, as did the market in general. We are entering a period of fragility when we will witness breakage in the economy as a result of the Fed’s interest rate hikes. It’s difficult to know at this point whether this event will be contagious, or not. As a practical matter, if you hold significant deposits in excess of insured amounts at a single bank, you should endeavor to scatter your funds among differently-named accounts or other institutions to come inside the insurance limits. As always, let us know if you have any questions.

Tax Laws, Sunsets, and Opportunities

Posted on 02.24.23 by Cascade in Investment

We will admit up front that this article will cover “too much”: that’s a by-product of Congress’ propensity to complicate tax laws and our own desire to give you a compact reference for future use. Of course, we are not tax experts, so please rely on your own accountant before making major moves on the tax front. First off, we will discuss high points of the new SECURE 2.0 retirement act, which expands on SECURE 1.0. Keep in mind that SECURE 1.0 had eight provisions; 2.0 has over 100 provisions. You’ll need an accountant’s help to take full advantage of this new legislation. Next, we’re going to touch on some laws that are set to revert to previous versions if Congress does not intervene.

SECURE 2.0

The first version of this act is best known for extending the age at which IRA holders must take required minimum distributions, for age 70 ½ to age 72. SECURE 2.0 bumps that once again, this year, to age 73. So if you are 72 this year, you have another year. In 2033, the age extends again, to 75. Other provisions include:

  • Reduced penalties if you miss an RMD
  • Increased catch up contributions starting in 2025 for participants aged 60-63.
  • Also starting in 2025, catch up contributions for savers of all ages who make more than $145,000 per year will need to be made in after tax dollars into a ROTH plan.
  • Under previous tax law, participants in ROTH 401ks had to take RMDs, while owners of ROTH IRAs did not. That has been changed to eliminate RMDs for the ROTH 401k starting in 2024.
  • Starting this year, IRA owners who use the Qualified Charitable Distribution tactic to direct their RMDs to charities can have a one-time, up to $50,000 per person opportunity to form a charitable trust with that money instead. So a couple could contribute $100,000 to a charitable trust, from which giving could extend for years. One note: the funds must be kept separate from any other charitable trust you already own. This one is tricky – so consult your estate attorney!
  • Excess 529 plan funds can, if you comply with several Byzantine rules, be rolled into a ROTH IRA for the beneficiary. Here, the rules are subject to some interpretation, so be sure to consult your accountant before attempting this one.
  • Multiple opportunities to withdraw penalty-free from IRA accounts for various sorts of emergencies.
  • Several employer-centric provisions including matching for ROTH 401ks, emergency savings ‘sidecar’ accounts to be offered alongside retirement plans, student loan payment matching, and several others. These provisions will not appear in employer plans overnight, and some may never appear, so stay tuned to your benefits manager at work.

Next up, the impending sunsets for important provisions of the 2018 tax act. This isn’t a call to action – rather, it’s a heads-up to keep track of the news around these laws, because if Congress does allow these provisions to sunset, everyone will be affected. The sunset occurs at the end of 2025. The most important items to track are:

  • Income tax brackets will rise at every level to the old brackets; the standard deduction, which was effectively doubled, will revert to half the current level; deduction formulas will change, including for home mortgage interest; and the child tax credit will revert to the less generous formula pre-2018.
  • The big one: the estate and gift tax exemption, now set at just over $12 million per individual and $24 million per couple, will re-set to the old limits, expected to be adjusted for inflation, of around $6.5 million per person. Should this re-set occur, we expect appointments with estate planning attorneys will be difficult to arrange due to the crush of trust restatements.

This brief is by no means a complete review of these important topics. We view ourselves as investment managers first, but secondarily, responsible for knowing just enough about changes in the law to alert you, so that you can consult with your own experts. Hopefully this piece has fulfilled that function.

Misconceptions About Social Security

Posted on 02.14.23 by Cascade in Investment

With political debates heating up, it is time to put to rest some myths about the Social Security program. We commonly hear that the trust fund will run out of money; that the trust fund has been raided by this or that politician; that individuals have a right to everything they paid in; or that current benefits will be cut. None of these are true. Let’s examine the program in more detail:

Social Security is made up of financial accounts kept at the US Treasury. Our taxes are paid into these funds along with interest earned from the securities owned by the program, and benefits are paid out. By law, the fund monies can only be used for benefits. No politician has ever “raided” the SS trust funds. The US government routinely borrows against the fund by selling it securities. But this is no different from an investor buying a Treasury note: the government is in that case borrowing from you, and you are repaid both interest and principal.

The fund works much like a corporate pension fund, taking in money while at the same time paying out money for benefits. It is a “pay as you go” system: young workers pay retirees’ benefits. SS was never designed to keep track of individual payments into the plan so those could be returned to you; it is a social safety net. It replaces more income for low income workers and less income for high earners. Actuarial calculations gauge how healthy the funding ratio is: SSA knows roughly who it will pay out to and for how long, and who is paying in. Currently, there is a surplus in the old age trust fund, but that is expected to disappear by 2035. The disability trust fund is fully funded and over a 75 year horizon will continue to have a surplus.

When the old age trust fund surplus runs out, there will still be enough money to pay all benefits at 80% of current levels. The fact that the benefit level does not match the current level is not due to any political party, law, or other nefarious behavior – in fact, Congress has taken action in the last few years to ease the funding situation for the trust fund and make it last longer. The real reason the trust fund surplus is declining is because people are living longer and drawing more from SS, and the retiring Baby Boom generation is one of the largest population cohorts this country has ever seen, while at the same time, there are fewer young workers who are paying into the system. This is a demographic and mathematical problem, and it will not go away until politicians decide to do something about it. Maintaining the safety net requires that taxes rise; benefits be means tested; retirement age be increased; or the cost of living adjustment be altered; or some combination of these. Declaring SS “off the table” is akin to subtracting from the retirement safety net that many depend on.

For further information, please see the following resources:

“10 Social Security Myths That Refuse to Die”, at this link:

https://www.aarp.org/retirement/social-security/info-2020/10-myths-explained.html#:~:text=Myth%20%235%3A%20The%20government%20raids,the%20federal%20government’s%20general%20fund.

“Actuarial Status of the Social Security Trust Funds”, at this link:

https://www.ssa.gov/policy/trust-funds-summary.html

“Top Ten Facts about Social Security”, at this link:

https://www.cbpp.org/research/social-security/top-ten-facts-about-social-security

It Matters What You Pay: Where are the Wall St. Darlings Now?

Posted on 11.21.22 by Michelle Rand in Investment, Personal Finance

It’s a good time to check in with some Wall Street darlings of the last few years. We found ourselves saying “no” to these stocks repeatedly, as they were retail investor favorites, reminding us of the late 1990s. Back then, dot-com stocks were all the rage and it didn’t matter what the company did, or how much it earned: somehow just the bravery of putting forth an unproven business idea was enough to get you capital. That’s not good enough for our portfolios. Companies need to be around for ten years or so, or be part of another company that’s been around for ten years or so, and making money is a must. We do not sign up for poor profit/loss ratios.

Today we’re going to check in with Beyond Meat and Carvana. Beyond Meat is a plant-based meat company that created sausages, burgers, and other meat-type foods from plant protein, flavorings, and additives. Several things have conspired against BYND. The first is the taste. Turns out, beef burger eaters are not so keen on pea protein. Second, the process of making plant foods is expensive. That makes the final product expensive – in some cases more so than chicken or beef. Third, BYND has a heavy-weight competitor called Impossible Foods that elected to remain private. It has more operating leeway and reduced prices across the board at one point, putting BYND at a disadvantage. Then, of course, BYND borrowed a ton of money. Debt is not a good thing when sales fall off.

The high price on this chart is $234. The current price is $13.28. That’s quite a fall from grace.

Carvana sells cars via an online platform that arranges for the customer to view the car, ask questions, make offers, buy insurance, finance the car, and have it delivered to his home. A kitschy part of the package is Carvana’s ‘vending machine’ that allows for on-the-spot pickup after a trial. Carvana has never made a profit and losses are taking a turn for the worst as expenses have skyrocketed.

The high price on this chart is $361. The current price is $7.06. This represents an historically horrific destruction of capital.

It is possible that neither of these companies will survive. Others are in the same boat, including several electric vehicle makers. For shareholders, the lesson is – it matters what you pay. For business owners, one lesson among many is – it matters what you spend.

Waiting for the Other Shoe to Drop

Posted on 09.23.22 by Michelle Rand in Investment

Sometimes the most difficult thing to do is nothing. Viewing the stock market over the last several days, maybe it’s easier than usual to do nothing since whatever you buy today is likely to go down tomorrow – but from our perspective, looking at ever cheaper prices it’s hard to pass up the opportunity to “buy low”.

Still, there’s a narrative that argues against our favored potential purchases lately: the housing stocks. That narrative goes like this:

  1. Housing stocks are cheap, yes, but earnings have yet to fall so they can get cheaper.
  2. Demand is strong and housing is underbuilt, yes, but cancellations are rising.
  3. Balance sheets are in great shape, yes, but will get worse before this is over.
  4. Dividends have gone up over the last few years, yes, but are still paltry.
  5. Earnings are strong now, yes, but will get worse.

The last argument needs better illumination from new data. We would like to see what happens to Toll, DH Horton, and others once earnings begin to fall.

So the waiting game is on. And that’s true of many segments of the market. We’d like to own more energy stocks; we’d like to own more industrial stocks; we might want another retail stock. But it’s better to stand out of the way for the time being.