Gill Capital Partners July 2024 Market Update
As we head into August, the Olympics are in full swing and are providing a welcome distraction from the news cycle. As America’s best athletes are competing, we also prepare for America’s best companies to report quarterly earnings, an important window into how growth is holding up and how quickly AI is impacting bottom lines. In addition to an update on earnings, we have more data on inflation and interest rates. We also have long-awaited clarification on inherited IRA rules. We will get into all of that below, but first, a few interesting facts about the Paris Olympics:
The 2024 Olympic Games in Paris are taking place exactly 100 years after Paris hosted the Olympics in 1924.
Paris will join London as the only two cities to host the Olympics three times. The Games were in Paris in 1900, 1924 and now in 2024. London hosted the Games in 1908, 1948 and 2012.
This was the first Olympic games where the opening ceremony was not held in a stadium, but rather on the Seine, the river that crosses the center of Paris.
There will be 32 sports played during the Paris 2024 Olympic Games and 329 medal events in total.
There will be one new sport in the 2024 Olympics: break dancing. Competition in the dance sport will comprise two events – one for men and one for women – where 16 B-Boys and 16 B-Girls will go face to face in solo battles.
For the first time ever, the 2024 Games will also take place in the French territory of Tahiti, where the surfing competition will be held on the Pacific island’s legendary Teahupoo wave.
There will be a new canoe event introduced at Paris 2024: Extreme slalom. Four athletes tip off a ramp at the same time and whoever gets to the bottom of the course first is the winner. There will be one event for men and one event for women.
Inflation & Other Economic Data Points
Looking at the recent data, we see general improvement across the board on inflation. The June Consumer Price Index (CPI), a broad measure of the cost of goods and services, increased by 3.0% year-over-year versus an expectation of 3.1%. This was the lowest level in more than three years. On a monthly basis, the index fell -0.1%, versus an expectation of an increase of 0.1%. Core CPI increased by 3.3% year-over-year versus an expectation of 3.4%, and on a monthly basis Core CPI rose by 0.1% versus an expectation of 0.2%. Finally, the personal expenditures price index (PCE), which has become the Federal Reserves preferred inflation gauge as of late, showed an increase of 0.1% for the month of June and was up 2.5% from a year ago, both in line with market estimates.
Falling energy prices were the single greatest contributor to the overall moderation of price inflation in June. The stubborn housing components, while still inflationary, are showing a decrease in the pace of inflation, which is a good sign. Stock markets viewed the inflation reports favorably as a sign that inflation is nearly under control and rate cuts will be implemented in the not-too-distant future.
We also received a series of softer economic data reports this week: construction spending, the ISM manufacturing index, and a monthly look at jobless claims. All three of these data points reflect a cooling in the U.S. economy. Construction spending showed a decline in the month of June; the ISM manufacturing survey showed that U.S. manufacturing sank into mild contractionary territory, while jobless claims rose to an 11-month high.
Our view –While inflation is still above the Fed’s target of 2%, it is clearly continuing to moderate and the Federal Reserve knows that the impact of higher rates won’t be fully priced in for several months. We would not be surprised to see annual inflation under 3% in the next month or two. The Fed is gaining confidence that inflation is coming under control, and this, combined with signs of weakness in the economy, likely gives the Federal Reserve enough room to begin cutting rates in September, a likelihood that is now priced into financial markets with a near 100% probability.
The Federal Reserve, Interest Rates & Asset Rotation
The Federal Reserve met this week and held interest rates steady at the current range of 5.25% to 5.5% but indicated that inflation is getting closer to its 2% target. They made no obvious indication that a rate cut was imminent; rather, they maintained that more progress is needed before rate cuts can happen. However, speaking with the media, Chair Jerome Powell indicated that while no decision has been made about actions at future meetings, a cut could come as soon as September if the economic data continues to show inflation easing.
Interest rates have moved significantly lower in anticipation of upcoming rate cuts, with the benchmark 10-year Treasury now hovering just below 4%, down from nearly 4.7% in April of this year.
Our view – Rate cuts are coming, and barring a significant change in current trends or the economic backdrop, an initial rate cut will likely come at the September meeting. Futures markets have already priced this in with near 100% probability and are beginning to price in the prospect of an even larger cut than originally forecasted. The Fed is walking a tight rope balancing their dual mandates; they see inflation moderating to near their target levels, but they also see softening in the economy and labor market, so they do not want to wait too long to return interest rates to a more normal level. We would not be surprised to see cuts come more aggressively when they do come, as has historically been the case in nearly every past easing cycle.
As the market continues to gain confidence around the prospect of rate cuts this year, we are seeing a rotation into more interest rate sensitive investments such as small- and mid-cap equities, emerging markets, and long-dated fixed income. These areas of the market have severely lagged the market leaders from the last couple of years, but very well could become the new market leaders if we see rate cuts materialize. Small-cap companies, as an example, are more sensitive to higher interest rates as they are often more highly leveraged and do not have the same access to capital markets as large-cap companies. As a result, lower rates can be more impactful for small businesses, and we often see them rally during periods of easing interest rates. We have seen these sectors outperform over the last few weeks and will be watching this dynamic closely. We maintain allocations to these asset classes and sectors in our client portfolios. We have made adjustments to our allocations in anticipation of lower rates to come, particularly on the fixed income side, where we have locked in higher rates that may not be around much longer.
Inherited IRA Clarifications
Inherited IRA owners have been waiting for clarification from the IRS for years and have finally received it. Prior to the SECURE Act, which was passed by Congress in 2019, heirs who inherited retirement accounts could take Required Minimum Distributions (RMDs) over their lifetimes, stretching out the distributions from tax advantaged accounts. This had the benefit of allowing more tax deferred growth, higher account growth potential, and potentially lower taxes owed on smaller distributions over one’s lifetime.
However, that changed in 2019. Among other things, the SECURE Act directed many people who inherited individual retirement accounts or qualified retirement accounts (401k, 403b, and other plans) in 2020 and beyond to take all of the money out within 10 years. There was uncertainty around whether inherited IRA owners were required to take (RMDs) over the ten-year period or if they could wait to take all of the funds out in the tenth year. If the latter scenario were allowed, this could have benefited investors with additional tax savings by allowing their funds to grow over the full ten years.
The IRS recently provided clarification that non-spouse beneficiaries must take the RMDs out of the inherited accounts each year over the ten-year period if the person who passed away was over the age of 73 and subject to RMDs during their lifetime. Though this new law has been in effect since 2020, no penalties have been levied by the IRS during the past several years due to the complexities and uncertainties around this. However, the penalty will apply in 2025 and beyond, and is equal to 25% of the amount that should have been withdrawn. Please note that this does not apply to spouses who inherit retirement accounts; there is an entirely different set of rules for spousal beneficiaries.
If you have questions regarding inherited IRA distributions, please reach out to your advisor and they will be happy to discuss this with you in more detail.
Enjoy the rest of summer and the Olympic Games!
As always, please let us know if you have any questions or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.