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Rockbridge Institutional – July 2024 Market Review

Market Review

Stocks

After being up 16% last quarter, the half-dozen Tech stocks that are expected to benefit from AI (Alphabet, Amazon, Apple, Meta, Microsoft and Nvidia) gave back 4% in July. These six stocks are about 27% of the S&P 500 and explain its subdued (1.2%) return in July. While the impact of AI will no doubt be profound, the volatility of these companies’ stock prices reflect the uncertainty of its future.

While the S&P 500 Index was up just 1%, the Russell 2000, a proxy index for domestic small company stocks, jumped over 10% in July, supplying some benefit of diversification. Indices reflecting non-domestic markets were little changed in July.

Expectations for the path of interest rates drive today’s stock market. Digesting the news from the Fed is a preoccupation of many investors and explains some of the volatility in stocks. Most signs are that interest rates are heading downward.

A well-diversified stock portfolio has rewarded investors recently (annual return of 13.5%). Over the past twelve months domestic large cap stocks (S&P 500) were up 22%, domestic small cap stocks (Russell 2000) were up 15%, stocks traded in internationally developed markets (EAFE) were up 10% and emerging market stocks were up 6%. A good 12-month period indeed.

Bonds

Falling yields pushed July returns up to about 1% at the short end and 2%-3% for longer maturities. Over the trailing 12-month period, bonds returned about 5%, reasonably close to longer-term expectations.  While flattening a bit, the Yield Curve remains downward sloping (longer-term yields below those at the shorter end) indicating reduced interest rates ahead. The spread between nominal and inflation-adjusted yields at five- and ten-year maturities indicate expected inflation of just above 2% – close to the Fed’s announced goals.

What we hear in the popular press notwithstanding, there is reasonably good news on the inflation front.  Over the past 12 months the CPI was up less than 3%. However, often the rate of inflation is confused with changes in price levels – a constant annual inflation rate of 3% increases price levels by 16% at the end of five years.

Interest Rates

Anticipation of interest rate changes affects both stock and bond markets. All eyes are on the Fed, expecting a reduction in the Federal Funds Rate soon, which will lead to reductions in other market- determined interest rates.

Lower interest rates reduce the cost of capital, which is positive for stocks. A lower capital cost makes more corporate investment opportunities profitable, increasing economic activity and expected earnings  (stock price is the present value of future corporate earnings discounted at the cost of capital – a lower discount rate means a higher present value).

Falling interest rates lead to falling yields and increasing bond prices and returns. Looking at individual bonds masks the effect of changing interest rates on bond values. Changing interest rates impact bonds of different maturities differently – the longer the time to maturity the greater the impact. The maturity of an individual bond shortens as it moves toward maturity. Proceeds will be reinvested at prevailing rates.

Lower interest rates are positive for stocks and bonds. However, since markets are forward looking, lower rates may already be baked into today’s prices. Surprises, including Fed behavior and future interest rate changes, affect short-term market movements. Volatility is the only sure prediction.

Recent Market Activity

The preceding discussion includes data and analysis as of the end of July – it has not been updated to include the market’s ups and downs of the first few days of August, which have been dramatic.  Explanations include the Fed voting to keep the Federal Funds Rate where it is; an uptick in unemployment; global slowdowns; the likelihood of recession; liquidity in Japanese markets; and senior traders vacationing in the Hamptons. However, these issues were well known prior to August, leaving random noise as the best explanation, confirming that markets are volatile and unpredictable

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New Options for SUNY ORP at TIAA

Starting July 23, 2024, TIAA is offering a new lifecycle fund program and an investment option for the SUNY Optional Retirement Program.

SUNY Targeted Allocation Retirement Series (STARS)

The STARS program is a hands-free approach that utilizes a combination of investment options to arrive at an allocation based on the participant’s projected retirement date. STARS has replaced the TIAA Access Nuveen Lifecycle variable annuities as the default investment option in the plan. Shown below are a few graphs that show the breakdown of the underlying investments and stock/bond mix based on the age brackets created by STARS:

Younger investors are encouraged to take on more risk with higher stock allocations, as they have a longer time horizon before retirement. Investors approaching retirement or those who have already retired have a higher percentage of bonds.. This gradual shift from bonds to stocks across birth years is a common approach for default investment options in employer retirement plans.

How to modify STARS or opt-out

Participants have the ability to opt-in or -out of the STARS program at any point in time. If you opt-out of STARS, you will need to select your investments on your own.

Contact your Rockbridge advisor if you need any advice on your TIAA allocation or if you have any questions regarding these changes.

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Revisiting I-Bonds

I-Bonds were a fantastic investment opportunity in 2022 as inflation rates were the highest we had seen in decades. I-Bonds purchased from May 1st through October 31st of 2022 earned a return of 9.62% (annualized) for the first six months. Since then, rates on I-Bonds purchased during that period in 2022 have been much more modest- moving from 6.48% to 3.38%, 3.94%, and currently 2.96%. If you purchased I-Bonds in 2022 or have been holding onto them for even longer- now might be a good time to re-evaluate your strategy.

Alternative Investment Options 

  • Cash/Cash Equivalents– If the monies you currently have tied up in I-Bonds are funds you’d like to have readily available, cash investment vehicles can earn you an annualized return in excess of 5%. For example, Schwab’s Value Advantage Money Market Fund (SWVXX) is currently paying 5.13%.
  • CDs / US Treasuries – If you don’t need the money today but anticipate needing to spend these assets in the short- or intermediate-term, transitioning I-Bond holdings to a Certificate of Deposit or US Treasury can potentially enhance your return, as well as guarantee your rate for a period of time, without increasing the risk of your investment. On the shorter side of the yield curve (6 month or less), you can still earn 5% or more (annualized) at today’s rates. Over 12-36 months, you can expect an annual return in the range of 4.0%-4.7%.
  • Market Portfolio – 2022 was a volatile year in the market and I-Bonds were a great place to avoid the negative impact of interest rate movements on your portfolio. If you parked cash in I-Bonds to avoid this risk and won’t need the funds for expenses in the foreseeable future, it might be worth considering adding these dollars back to your market portfolio, at whatever risk tolerance (stock/bond mix) is appropriate for you. This is ultimately where we believe an investor will receive the highest risk-adjusted return in the long-run.

Implications of selling I-Bonds

  • Interest Penalty – If you have held your I-Bonds for less than 5 years, there is a 3-month interest penalty on surrendering the bonds. Depending on your plan for reinvestment of the proceeds and the current interest rate you are earning, you could still be better off in the long run after accounting for the penalty.
  • Tax – Unless you chose to pay the tax annually, you will owe federal income taxes on the interest earned over the period in which you held your I-Bonds. This income is omitted from state and local tax calculations. Also, if you were subject to the 3-month early withdrawal penalty, you would not owe any tax on this amount because it was never received as income.

Summary

If you are currently holding I-Bonds and are unsure of your best path forward, contact a Rockbridge advisor today and we would be happy to determine an optimal strategy for your individual circumstances.

 

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