The war that began this week between Russia and the Ukraine is a human tragedy and a stark reminder that dollars and cents are secondary to health and safety. Some of us who have friends and family in the areas affected by war are focused on the wellbeing of their loved ones. But for most American investors, the immediate impact of the conflict is seen with the change in the value of their investments.

War is bad for stocks. Companies are worth the present value of their future profits. War destroys wealth whereas work creates it. Wars reduces commerce, making companies less profitable and worth less. That was seen on Thursday, February 24th when the U.S. Stock market opened down 2.5%. It looked like Wall Street might suffer a historically bad day, but by the close of trading the market was up 1.6%, a stunning reversal. The change was more pronounced in technology stocks with Cathy Wood’s ARKK going from -8% to +6%, a 14% intraday change! So what gives?

It’s difficult to know exactly why the market moves the way it does, but yesterday’s price action seemed especially tied to expectations from the Federal Reserve. At the moment, the market is pricing in hawkish moves by the Federal Reserve over the coming year or two. These will take the form of interest rate hikes and the elimination of asset purchases or even asset sales, all to combat inflation.

Those moves are expected to be harmful to the price of stocks, especially growth stocks which are more sensitive to interest rate changes. If war in Eastern Europe is going to be a detriment to economic activity, the Federal Reserve may not act as aggressively which may be net beneficial for stocks. Keep in mind, Ukraine is a relatively poor and small country and Russian Stocks only makes up a small fraction (0.25%) of the equity allocation portion of client portfolios.

There are two main takeaways. The first is that markets are so good at instantly pricing in news. If you had wanted to sell out of stocks yesterday at 10am because of the start of the war, you were too late. The market had already sold off on that news, so selling would have been no benefit to you.

The second is that everything is connected and when one lever is moving over here another level is moving over there. How could the outbreak of war possibly be a good thing for stocks? Because of the Federal Reserve. It’s so hard to know how other elements of the market will react to news that even if you knew the news ahead of time, you still may be wrong in anticipating how markets will react.

Again, we are reminded not to try and outsmart the market. Establish an investment portfolio you are comfortable with and stick to it!

The Federal Reserve met in December and outlined a new course for monetary policy going forward. They signaled two big changes:

  1. The Fed will stop buying Treasury Bonds and Mortgage-Backed Securities by March
  2. The Fed expects to raise interest rates 3 times next year, bringing the Fed Funds rate from a target of 0.00% – 0.25% to 0.75% – 1.00%.

The Federal Reserve has a “dual mandate.” The two things they are focused on are keeping the population at full employment and keeping inflation in check. Economists generally view full employment as an unemployment rate of 5% or lower and the Fed targets long-term inflation as 2%.

These moves are expected to be modestly harmful to asset prices and represent action meant to cool an economy that is overheating. There is good reason for this, in November, the unemployment rate dropped to 4.2%. At the same time, the Federal Reserve is expecting inflation of 5.3% for 2021 and real GDP growth of 5.5%.

What does that mean for us?

Higher Short-Term Interest Rates: Remember a few years ago (2018) when you could actually get some return from a high-yield savings account or a 1-year CD? That’s expected to come back. A year from now we should see these paying north of 1%. If the Fed’s longer-term expectations are realized, by the end of 2024 these numbers will be around 2.5%.

Higher Mortgage Rates: With the Fed raising the Fed Funds rate and no longer buying longer-term bonds, markets expect yields to rise most everywhere, including with Mortgages. When the Fed last had multiple rate hikes in a year (2017 – 2018), we saw 30-year mortgage rates go from 4% to 4.9%. Current mortgage rates sit at 3.1%. As these rates rise, expect the housing market to cool as the carrying cost of homes increases.

Lower Returns over the short-term: We’ve been warning our clients of this for several years now, and we may finally be right (unfortunately). As interest rates rise, the value of existing bonds declines. We’ve seen that this year and it could happen again. Rising interest rates affects not only bonds, but stocks too. In calculating the value of a stock, you discount future cash flows from the stock. Higher interest rates mean a higher discount rate which leads to a lower current price for that stock. However, it’s not all bad news. While the price of existing assets goes down, the expected return going forward increases.

Covid-19 didn’t just bring volatility to the stock market, it also brought volatility to the labor market. The number of unemployed quadrupled from 5.7 million (3.5%) in February 2020 to 23.1 million (14.8%) in April 2020. Not surprisingly, the number of job openings decreased from 7.1 million to 4.6 million at that same time.

Fortunately, things rapidly improved. The number of unemployed has declined to 7.7 million (4.8%) and the number of job openings has jumped to 10.9 million. Having 3.2 million more openings than “unemployed” is the largest we’ve ever seen and the reason there have been headlines about staff shortages.

Another positive is the decline of the number of persons not in the labor force who want a job. That number went from 5 million to 10 million in two months, and back down to 6.0 million by September 2021.

By and large, the labor force is strong. One of the best metrics for employment/ unemployment is the “Employment-Population Ratio – 25-54 yrs.” This tracks the percentage of people aged 25-54 in the U.S. who have a job. This figure currently stands at 78%, down from 80.4% just prior to the pandemic but up from 69.6% in April 2020. There are about 130 million Americans in these prime working-age years. To get back to where we were before the pandemic, we’ll need another 3.2 million Americans to get hired.

On the wage side of things, the situation has actually improved. The average weekly earnings of all employees went from $980 in February 2020 to $1,074 last month. On an inflation adjusted basis that’s an increase of 3.9%, slightly more than offsetting the drop in employment.

That means on an inflation and population adjusted basis, a little more money is being paid in wages today as was before the pandemic. It’s hard to overstate how remarkable that is. In addition to the Federal Reserve’s efforts, the $5.3 trillion of fiscal stimulus from the Federal government has been effective at keeping the economy humming.

The strength of the labor market has consequences for the Federal Reserve and the stock market. With the labor market at or better than historical averages (and inflation running a bit hot) the Fed’s reason for its accommodative monetary policy is diminishing.

If these economic trends continue as expected, the Fed will soon reduce their $120 billion/month in bond purchases, then they will eliminate these purchases, and finally the Fed will start selling bonds back to the market. In the middle of that, the Fed will likely increase short-term interest rates. These actions pose headwinds for stock and bond returns. Since 1976, the global stock market has returned 10.6% annualized and the U.S. bond market has returned 7.1%. It’s unlikely we will continue to see these numbers from stocks and a certainty we won’t from bonds.

Last week I wrote an article that dove into what the Build Back Better Act could mean for those currently using the Backdoor Roth IRA strategy. While that is a significant change that could be on the horizon, it is only one of many currently proposed in the several hundred-page plan. Shown below is a list of other items proposed in the Build Back Better Act:

  • Increased income taxes and payroll taxes on certain taxpayers with high incomes ($400k+)
  • Capping the tax benefit of itemized deductions for those earning $400k+
  • Increased capital gains rates for high income earners
  • Raise corporate tax rates and implement a 15% corporate minimum tax
  • Cut the estate/gift/GST exemption in half
  • Limit the ability for taxpayers in high tax brackets to do traditional Roth conversions in the future

While none of these changes have been put into law yet, it is our job to prepare for how proposed tax code changes could impact our clients. If you are curious as to how any of the above provisions might impact your financial situation, don’t hesitate to schedule a call.

The year-end process can be stressful for many investors and 2021 is no different in terms of having proposed changes to the federal tax code. The proposed Build Back Better Act is currently structured to limit those who can use the “Backdoor Roth” strategy and/or make Roth Conversions in general. We don’t know if this bill, in its current form, will become law, but here are some considerations.

The Backdoor Roth Strategy

The Backdoor Roth strategy is a way for high wage earners to make contributions to a Roth IRA, even if they are above the income threshold to make direct Roth contributions.  The way the backdoor Roth strategy works is that an investor makes a non-deductible (after-tax) contribution to an empty Traditional IRA and then immediately makes a Roth conversion for the amount of the contribution. There is no income limit for making non-deductible contributions to a Traditional IRA and since they contributed after-tax money, there’s no tax impact on the conversion.

This is a great strategy that we recommend for all high wage earners who are already maximizing pre-tax contributions to employer plans and do not have existing pre-tax assets in a Traditional IRA.

What’s proposed?

Under current tax law, an individual with a modified adjusted gross income (MAGI) equal to or greater than $140,000 or a married couple filing jointly with a MAGI equal to or greater than $208,000 can’t contribute directly to a Roth IRA.  However, anyone, regardless of their income, can use the Backdoor Roth strategy. If the Build Back Better Act is passed into law, after-tax Traditional IRA contributions will not be allowed to be converted to a Roth IRA at any income level, effective for distributions, transfers, and contributions made after December 31, 2021.

This act has not yet been passed, but we want our clients to be prepared if it becomes law. If you have any questions about the Backdoor Roth strategy or the proposed changes, don’t hesitate to reach out to your advisor or schedule a call.

GameStop has been in the news in the last week as the share price jumped from $35 to $350, and is up from an April intraday low of $2.57. There are lots of things going on with this but the one getting the most attention is the “short squeeze.” We’re going to describe what a short is, what a short squeeze is, and how it’s playing out with GameStop.

A short is a bet on a stock decreasing in value. In an effort to improve market efficiency and for some to hedge risk, the SEC allows certain individuals to sell a share of a stock that they don’t really own. For example, say investor A owns $100,000 of Apple, and they plan to hold it for at least a year. Meanwhile, speculator B thinks Apple is overvalued and will go down over the next year. A & B can enter an agreement where B borrows the shares A owns with the promise to give those shares back in one year, plus $1,000 for providing the shares.

Investor A likes this because they will end up with the same long position and they make $1,000. B likes it because B can now sell those shares in the market. Because B has temporarily borrowed these shares and has locked in a value to give them back, they don’t really have exposure to Apple. When B sells the Apple shares on the open market, they now own negative Apple, which is called “being short.” Because B must give A back the shares in a year, B is betting that Apple will go down in value allowing them to buy Apple back at a lower price a year from now.

In our example, if Apple’s price drops in half, B can buy back the Apple position for $50,000. B received $100,000 for selling the borrowed Apple at the start of the year so B nets $49,000. However, if Apple goes up 50% and B has to buy the shares back in a year it will cost B $150,000, for a loss of $51,000.

Shorting a stock is risky for two reasons. Stocks, in theory, have no maximum share price, so there is no limit to the amount of loss one can incur from shorting a stock. The other reason is that stocks as a whole have always gone up over time. The efficient market theory would say engaging in a short position has a negative expected return.

A Short Squeeze is when speculators who have shorted a stock are forced to “cover” their short by buying back the stock. This can lead to a snowballing effect where buying fuels more buying, driving the price of the stock higher. For example, a speculator who is renewing a short on a daily basis may suddenly have the lender decide they don’t want to lend anymore and asks for the share back. Alternatively, the lender of the stock may require the speculator to post margin based on how much the position has moved against the speculator. At some point, if it’s moved so much that the speculator no longer has the cash margin, the speculator will be forced out of the position. Either way, the speculator must buy shares, driving the price up.

There is another phenomenon, called a gamma trap, that is sparked by a different type of speculator who likes the stock. If that speculator buys a call option on the stock, the wall-street trading desk that wrote the option may hedge their position by buying the stock in the open market. If enough speculators are buying calls, that will drive the price higher, which in turn fuels more hedging by the options desk (people describe this in terms of delta and gamma). This is a way for a speculator to magnify the effect their dollars have on the price of a stock. This coupled with the short squeeze can create a cycle of buying that becomes self-fulfilling.

GameStop has become an incredible case study in short squeezes. 10 years ago, GameStop had about $9.5 billion in revenue and was making $400 million a year. Today, GameStop has $6 billion in revenue and is losing about $400 million a year. The book value of equity has shrunk from $3 billion to $600 million. As COVID-19 reduces retail foot traffic and more video games are downloaded directly from the publisher or from companies like Steam and Origin, you can understand how some would speculate the company’s stock will decline.

As a result, many hedge funds and other “Wall Streeters” have shorted GameStop. In fact, so many have shorted the company that the number of shares shorted exceeded the total number of shares available for trading (yes that is possible). This had been effective and lucrative as GameStop’s share price steadily declined from $30 in 2016 to about $4 for most of 2020 (at $4, GameStop has a market capitalization of $280 million).

However, a new board member and an internet forum have shifted the sentiment. What started as a fundamental case for a higher valuation turned into an internet movement to beat Wall Street at their own game. At this moment it looks like the internet trolls are winning. Those who bought GameStop last Friday have seen the share price move from $50 to $350 as of today’s close ($24.5 billion valuation). Meanwhile, short sellers have either taken an enormous mark to market loss or locked in an enormous loss as they’ve exited their position.

The Wall Street Journal reported that hedge fund Melvin Capital is down 30% this year due to shorting companies like GameStop. With $13 billion in assets, that amounts to a loss of nearly $4 billion for the speculators who outsourced their speculating to Melvin.

Where we head from here is anyone’s guess. The $350/share at today’s close could be a stop on its way to $1,000+, it may also be the all-time high. At some point in the future, emoji-filled internet commenting will return to normal, short selling will stabilize, and GameStop’s share price will return to the present value of expected future profits. $25 billion seems high for a company struggling to break even with $6 billion in revenue and no expected revenue growth, but turn arounds do happen and the press around the stock may help drive sales. It will be up to management to try and make that boost permanent rather than temporary, which will be a difficult task.

I see a few glaring takeaways. First, this isn’t investing, it’s playing a game. Providing capital so a company can produce a good or service and generate wealth for society provides an expected return for an investor. Shorting a company, or trying to squeeze a short, or buying options, does not generate wealth and does not come with an expected return. As every trade has a bid/ask spread, you must win a little more than half the time just to break even and the sum of all players is negative.

It’s also a reminder of why paying a lot for active management is a bad idea. While those who gave their money to Melvin are down 30% in 2021, the owners of Melvin are up 0.16% this month because they charge a 2% management fee. Paying 2 & 20, or even 1% for active management is unlikely to benefit you. Remember, the average of all investors, not including management fees, is the market average. Math dictates the majority of active management must underperform a low-cost fund after taking into account the fees they charge.

Lastly, if you want to buy an individual stock (which Rockbridge doesn’t recommend), do so because you plan to hold it for many years. Buying a company now because you think you think it will make you rich later today or next week is not a prudent way to manage your money.

As others speculate on things they can’t control like the price of GameStop’s stock, instead focus on things you can. Are you taking full advantage of your 401(k) or Roth IRA this year? What about a 529? Do you have enough term life insurance? Do you have any 1099 income that can be saved in a self-employed retirement account? Do you feel comfortable with your Social Security claiming and portfolio distribution strategies in retirement? Reach out to your Rockbridge advisor so we can make sure you’re on the right path in these areas and don’t worry about GameStop, which has fallen 31% to $240 as I type this…

Congress created the Paycheck Protection Program (PPP), to provide liquidity to small businesses dealing with the effects of the economic shutdown.  It was clear from the language in the CARES Act that loans used for covered expenses would not be included in a business’ gross income. However, the Bill was silent on the deductibility of these covered expenses. The IRS recently released guidance taking the position that allowing businesses to deduct expenses paid with tax exempt income (the PPP loan) would provide a “double tax benefit.” Now, after many small businesses have taken loan money in order to continue paying their employees, make rent, or cover utility costs, they face the possibility that they will not be able to deduct these expenses if their PPP loan is ultimately forgiven.

Lawmakers from both sides of the aisle are critical of this position and are proposing legislation that would override the IRS on this issue. Senators John Cornyn, R-Texas, Charles Grassley, R-Iowa, Ron Wyden, D-Ore., Marco Rubio, R-Fla., and Tom Carper, D-Del. proposed the Small Business Expense Protection Act, an amendment to the CARES Act which would allow covered expenses to be deductible.

A separate piece of legislation enacted by The House of Representatives, called the Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act, also addresses the deductibility issue. In addition to correcting the deductibility issue, the HEROES Act would allow employers receiving loan forgiveness under the PPP to take advantage of the CARES Act’s payroll tax deferral provisions, which was prohibited in the CARES Act.

So where does this leave small business owners who are wondering how to account for these PPP financed expenses? Unless Congress passes or negotiates a fix, they will have to assume that they will not get both loan forgiveness and the ability to deduct the expenses paid for with loan proceeds. This could ultimately mean companies may need to make larger than anticipated estimated tax payments by July 15th. Hopefully Congress will act swiftly to settle this issue so that business owners can turn their attention to safely reopening as soon as they get the green light to do so.

In order to provide the best advice to our clients, we pay close attention to updates and guidance on the various CARES Act provisions, including the PPP. As soon as we know more, we will release a follow-up article with the latest information and impact to small business owners.


The IRS is extending the federal income tax filing deadline to July 15 as part of a growing effort to stem the financial pain from the coronavirus pandemic, Treasury Secretary Steven Mnuchin announced Friday.

The move gives Americans three months more than they normally would have to file their income tax returns for the 2019 tax year, without incurring interest or penalties.

President Donald Trump later Friday said that “hopefully” by the time the new deadline arrives “people will be getting back to their lives.”

“At @realDonaldTrump’s direction, we are moving Tax Day from April 15 to July 15,” Mnuchin wrote in a tweet about the extension.

“All taxpayers and businesses will have this additional time to file and make payments without interest or penalties,” he wrote.

Trump echoed that suggestion during a White House press conference.

Most Americans are entitled to refunds when they file their federal tax returns.

As of March 13, the Internal Revenue Service had issued 59.2 million refunds out of the 76.2 million million individual income tax returns it had received, or 77.7% of the total number of returns filed by that date.

The average refund check was $2,973, according to IRS data.

Many individual states already had extended their own tax filing deadlines to various dates to give people relief from the financial fallout of the coronavirus outbreak, which has shuttered businesses nationwide and led to large-scale layoffs.

The IRS move will increase pressure on states to align their deadlines with the new one for federal income tax returns.

New York Gov. Andrew Cuomo, asked at a press conference if state residents should pay their state income taxes by the New York deadline of April 15, said the new federal guideline should be followed.

The IRS did not immediately return a call for comment from CNBC. It is not clear if the deadline extension also will include the deadline for funding Individual Retirement Accounts for the 2019 tax year.

A proposal to extend the federal filing deadline to July was included in the Senate’s coronavirus economic stimulus bill, which was released Thursday by Majority Leader Mitch McConnell, R-Ky.

That proposed relief package calls for new federal spending that could top $1 trillion.

Earlier this week, the Treasury Department released guidance that would have pushed back only the deadline for making federal tax payments — not for filing tax returns —  to July 15.

That 90-day reprieve on payments would have applied to 2019 income taxes owed, plus first-quarter tax payments that would have been due on April 15.

Federal lawmakers and members of the tax preparation community had criticized the proposal to have different dates for filing tax returns and making payments. Mnuchin’s announcement ends that debate by having returns and payments each due by July 15.

The White House declined to comment on Mnuchin’s announcement.