Obermeyer Wood News - Fall 2023 — Obermeyer Wood Investment Counsel

MARKETPOINT: It's (Still) All About the Fed

September continued to live up to its reputation as being a challenging month for equities as the market cooled off after an impressive, albeit uneven, 2023 rally that lasted through July. While it was disappointing to see some of the year’s gains reversed, it is important to keep in mind that sudden pullbacks are not unusual; on average, investors can expect to see a 5% decline up to three times per year.¹ Rising interest rates and economic slowdown concerns weighed on sentiment as investors remain hyper-focused on the Federal Reserve (the Fed).

There is nothing moving markets more than the Fed’s actions and, more recently, words. In July, the central bank raised its benchmark federal funds rate to 5.25–5.50%² and elected to hold rates level at its September meeting³. The rate decisions in those two meetings were not surprising. However, market participants reacted negatively to Chairman Jerome Powell’s statements in which he signaled that interest rates were likely to remain elevated well into next year, dashing hopes that rates would come down in late 2023 or early 2024. “We want to see convincing evidence really that we have reached the appropriate level, and we’re seeing progress and we welcome that. But, you know, we need to see more progress before we’ll be willing to reach that conclusion,” Powell said.⁴ With the prospects of a “higher-for-longer” interest rate environment increasing, investor sentiment and equities retreated. Ten-year US Treasury yields reached 4.7% for the first time since 2007⁵, as the prospect for higher real interest rates shook investors, and the long end of the yield curve began to flatten out.

Inflation, Jobs, and a Rolling Recession

The central bank remains laser-focused on attempting to achieve a soft landing – financial shorthand for a cooling of the economy without causing a severe recession. As the Fed attempts to navigate the complex economic landscape, three factors stand at the forefront of its concern: inflation, the labor market's robustness, and the specter of recession.

Inflation has significantly retreated since peaking at 9.1% in June 2022.⁶ In June 2023, annual inflation was just 1/3 of what it had been 12 months prior.⁷ Initially triggered by an imbalance between money supply and goods availability, we have reached a point where excess demand persists despite the resolution of many supply-side issues. While the inflationary fires have been quelled significantly, the Federal Reserve remains cautious, seeking additional and sustained progress toward its stated goal of 2% annual inflation before considering downward rate adjustments.

Complicating matters for the Fed, the labor market has proved astonishingly resilient. A robust job market means more paychecks and, consequently, more spending, which supports higher prices. The latest job report from the Bureau of Labor Statistics showed that the U.S. labor market remains quite strong. A rise in unemployment would help the Fed in its goal of reducing inflation, but to achieve a soft landing, it will want to continue to tighten conditions to temper wage growth and keep a lid on additional hiring without causing a wave of job losses, potentially tipping the economy into a moderate-to-severe recession.

On the topic of recession, the economic outlook has evolved significantly since the start of the year. In late 2022, economists forecast a 70% likelihood of recession,⁸ but this sentiment has since shifted, with some estimates now as low as 20%.⁹ So, where is the downturn that had been so widely predicted earlier this year? To be frank, it is very possible that it is still on the horizon. Another plausible explanation is that we are already in a “rolling recession" – a series of sector-specific economic contractions. Manufacturing, chemicals, freight, technology, finance, residential and commercial real estate, mergers and acquisitions, and advertising have all experienced mild-to-significant slowdowns over the last 12 months.¹⁰ Strong consumer spending during that period, which has fueled sustained spending in the service sectors, especially travel and entertainment, may be what has saved the economy from a full-blown contraction. Will we keep rolling along to a soft landing? It is possible, but nothing is guaranteed.

Stocks Cool, Yields Persist

Shifting gears to look at the market, investors should not forget the strong start to the year and keep the recent downturn in the market in perspective. After a dismal 2022, few thought the market would be where it is today, and it's not just because of the artificial intelligence (AI) revolution. Corporate earnings were surprisingly strong, providing a solid foundation for the market's upward trajectory. Additionally, stronger-than-expected GDP numbers¹¹ and other economic indicators have bolstered the belief in a "soft landing" scenario for the economy. As a result, investors have benefited most from exposure to large companies, particularly in the technology sector, fueling the market’s rise this year. However, keeping in mind that market trends are cyclical, there will come a time when smaller companies and a broader group of industries rise in value and reverse the current trend.

While higher interest rates have weighed on stocks, the fixed-income market is providing investors with much-welcome opportunities for return on investment on more conservative securities – the best we have seen in about 15 years. We remain focused on high-quality bonds and look to add duration for select situations. Six-month to three-year treasuries and money market funds continue to be our preferred choices for many of our clients’ fixed-income or cash allocations.

^{2-year US Treasury Yield to Maturity – 2010-Present Source: Federal Reserve Economic Data, Federal Reserve Bank of St. Louis}

Navigating with Cautious Optimism

Looking ahead, we see competing trends offering both hope and uncertainty. Let’s start with the reasons for caution. First, a rolling recession, if happening, highlights the risk of significant sector exposure, which is why we seek to stay diversified and have been increasing diversification in client stock holdings. The health of the consumer is also a concern. As pandemic-era savings dwindle and sustained inflation erodes purchasing power, spending is likely to taper off in late 2023 and early 2024.¹² And finally, geopolitical developments remain significant and unpredictable. The Russia-Ukraine war appears to be at a stalemate, meaning continued human suffering, sustained pressure on global energy and food prices, and the possibility for more regional conflict. Additionally, U.S.-China relations remain fragile as the two largest economies in the world compete for strategic global influence on a variety of fronts, including Taiwan, South America, and Africa. China is in the midst of a significant deceleration of its economy, with a dark cloud of debt hanging over its real estate sector, which has made up as much as ¼ of its economy in the past.¹³ Investors will be keeping an eye on the world’s second-largest economy to see whether Beijing steps in with significant stimulus or risks potential fallout across other sectors.

Despite these cautionary trends, we do see reasons for hope. We may be close to the end of the Fed rate hiking cycle, and the chances of a soft landing are high, though not guaranteed. Innovation and the emergence of AI, particularly among U.S. tech and tech-enabled companies, offer exciting prospects for investors. Moreover, the recent dip in the markets this past quarter is helping valuations return closer to normal averages (see chart below), presenting potential opportunities for investors with cash on the sidelines.

^{Source: J.P. Morgan Asset Management Guide to the Markets – September 30, 2023}

One truth in investing remains constant: one can't consistently predict the future. However, our philosophy around long-term investing remains consistent. We construct portfolios and financial plans that account for a range of potential outcomes, seeking to put our clients in the best position possible over the long term while minimizing risk. It's been a positive year for investors, and our optimism is steadfast and grounded in our decades of experience. Remember, we are here for you—should you have any questions or wish to discuss your portfolio or financial situation, do not hesitate to reach out. Your financial well-being is our top priority.

[1] https://www.capitalgroup.com/individual/planning/market-fluctuations/past-market-declines.html
[2] https://www.federalreserve.gov/newsevents/pressreleases/monetary20230726a.htm
[3] https://www.federalreserve.gov/newsevents/pressreleases/monetary20230920a.htm
[4] https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20230920.pdf
[5] https://www.barrons.com/livecoverage/stock-market-today-100323/card/10-year-treasury-yield-races-higher-DLCvNvep39o1Chn2jUvo
[6] https://www.dol.gov/newsroom/economicdata/cpi_07132022.pdf
[7] https://www.bls.gov/opub/ted/2023/consumer-prices-up-3-0-percent-over-the-year-ended-june-2023
[8] https://www.bloomberg.com/news/articles/2022-12-20/economists-place-70-chance-for-us-recession-in-2023
[9] https://www.goldmansachs.com/intelligence/pages/the-probability-of-us-recession-in-the-next-year-has-fallen-to-20-percent.html
[10] https://www.bloomberg.com/opinion/articles/2023-08-08/rolling-recessions-are-roiling-lots-of-industries#xj4y7vzkg
[11] https://www.cnbc.com/2023/07/27/gdp-q2-2023-.html
[12] https://www.cbo.gov/system/files/2023-07/59258-econ-outlook.pdf
[13] https://www.wsj.com/world/china/china-comes-under-growing-pressure-to-fix-the-countrys-housing-market-709f8d0d

SAVING FOR THE FUTURE GENERATION: WHICH KIND OF ACCOUNT IS RIGHT FOR YOU?

For many families, the rising cost of higher education has made saving for college a priority. Some parents and grandparents open accounts as soon as a baby is born to harness the power of compound interest.

While 529 plans are a popular way to save for higher education expenses, other options exist. To help you decide which one makes the most sense for your family and finances, we’ve assembled the chart below that compares 529 plans and custodial accounts.

Custodial accounts have existed since the 1950s. Depending on the type of account, they can hold cash, securities, mutual funds, insurance policies, real estate, fine art, and other property.

The 529 plan was conceived in 2001 and was developed to help families save and invest specifically for the cost of post-secondary education. Account owners in some states (not including Colorado) could use the funds to pay for K-12 educational expenses as well beginning in 2017.

If you are saving specifically for college, a 529 plan might be the better option. 529 plans offer Colorado residents tax and financial aid advantages. If you want more flexibility regarding how the money can be used, or if you want your child to gain control of the account when they reach the age of majority, then a custodial account might be better. We are happy to discuss the options with you, so reach out to your financial advisor for more information and guidance.

FIRM UPDATE: OBERMEYER WOOD RECOGNIZED BY CNBC AND BARRON’S

We are excited to announce that our firm has been recognized by two leading financial news outlets in the last few weeks. CNBC and Barron’s each released their Top 100 rankings of independent advisors in the U.S., and we are honored to be on the lists.

For the first time, Obermeyer Wood has earned a spot on the renowned CNBC Financial Advisor 100 ranking for 2023. Noteworthy about this recognition is CNBC's comprehensive assessment, which extends beyond assets under management. The evaluation encompasses compliance and regulatory history, areas of specialization, and employee expertise. Particularly, CNBC sought firms that excel in guiding clients through intricate financial decisions that transcend their investment portfolios.

"Our clients are seeking guidance not just on their portfolios but on their whole financial picture,” said Ali Phillips, executive vice president and partner at Obermeyer Wood. “We see ourselves as trusted partners for our clients as they navigate all of life's decisions."

In addition to the CNBC recognition, Wally Obermeyer, representing Obermeyer Wood, achieved an impressive ranking at No. 74 in Barron's annual list of Top 100 Independent Wealth Advisors. This marks his 16th appearance on this esteemed list, which considers both quantitative and qualitative factors to identify top independent wealth advisors.

We want to thank our clients who make these awards possible. For more information and for important disclosures about third party rankings and their methodologies, please visit our website.

YEAR-END REMINDERS: RMDS AND GIFTING

As we near the final months of 2023, we would like to give our clients a few year-end reminders related to required minimum distributions (RMDs) and gifting. Most clients 73 and older, or those with inherited IRAs, must take an annual RMD by the end of this year to avoid penalties. We have already reached out to some clients to satisfy 2023 RMDs, and we will continue reaching out to those of you with unfulfilled RMDs over the next few months. Please contact our team if you have any questions or concerns about these distributions, or if you would like us to coordinate with any of your trusted tax professionals.

The end of the year and holiday season are popular times for many clients to do charitable or family gifting. If you are at least 70 ½ and have an IRA, you can satisfy all or part of your RMD by making a qualified charitable distributions (QCD). Making a QCD can also reduce your taxable income. Be sure to talk to your CPA or other tax professional about whether this strategy makes sense for you.

If you are considering gifting cash or securities, either to charity or to a family member, and would like our help to strategize or coordinate such gifts, please let us know. This kind of gifting offers many benefits, including potentially reducing the size of your taxable estate while allowing you to see the impact your gift has.

Keep in mind that many custodians have mid-December transaction deadlines for various gifting practices. We urge you to plan ahead and coordinate with your tax professional. We are also happy to coordinate with them.

MARKETPOINT: It's (Still) All About the Fed

SAVING FOR THE FUTURE GENERATION: WHICH KIND OF ACCOUNT IS RIGHT FOR YOU?

RECOMMENDED READING: Outlive: The Science & Art of Longevity

FIRM UPDATE: OBERMEYER WOOD RECOGNIZED BY CNBC AND BARRON’S