January 14th, 2022
Markets declined for the second week of trading for 2022. Like last week, bulls initially appeared ready to buy into the dip following last week’s sell-off. The buying helped drive the Nasdaq higher for three consecutive sessions. Optimism faded, however, following a weaker than expected start to the earnings season. Expense growth at financial giants JPMorgan and Citigroup became emblematic for what traders fear might be seen more broadly once we get deeper into the reporting cycle. Economic reports this week also came in weaker than expected. Retail sales dropped in December as consumers pulled back amidst Omicron and the cessation of stimulus payments. Inflation garnered considerable attention as well with consumer prices hitting a near 40-year high. A wave of negativity caused markets to reverse course mid-week with the S&P 500 and Nasdaq falling -0.30% and -0.28%, respectively, by the final bell.
Retail Sales Cool
December had been expected to be a shopping extravaganza given rising wages and the anticipation of higher foot traffic at brick-and-mortar stores following last year’s Covid-induced hiatus. Unfortunately, shoppers didn’t cooperate with that narrative and retail sales fell -1.90% for the month. Excluding autos, the sales decline was even more pronounced, dropping -2.30%. The month-to-month decline correlates with the emergence of the Omicron strain, which accelerated in lockstep with the busiest part of the holiday shopping season. Restaurants and bars saw their sales drop -0.80% and with fewer travelers on the road, gas stations saw sales dip -0.70%. Online shopping also took it on the chin during the month, down -8.70%. Traders reacted negatively to the news release–fearing that it was an inflation induced pullback–but this pattern has repeated itself with each successive, major Covid variant. Each time, sales have simply been shifted to future periods. The cause of the pullback was more than likely due to multiple factors, not the least of which is the fact that there were not as many goods on the shelves and the fact that many consumers purchased their holiday gifts earlier this year (making the month-to-month comparison look worse). December’s reading indicates a tough start to 2022, but one month’s readings does not a year make.
Consumers Remember the ‘80s
The Consumer Price Index rose 7.00% year-over-year (yoy) in December. For those of us old enough to remember having seen prices rise this sharply in the past, you would have been working on your brand new Commodore 64 while rocking out to Olivia Newton-John’s “Physical” playing on a boombox in the background. That’s 1982 for anyone whom those cultural references have no relevance. December’s price reading accelerated slightly over November’s 6.80% reading. Surging car and energy prices continued to be the core contributors to the index’s increase. Year-over-year, used car prices have risen 37.30%. It’s been a good time to be a used car salesman given that more people are wanting cars at a time when supply chain constraints have limited the number of new vehicles rolling off the factory floor. Consumers wanting that new car smell have seen prices rise 11.80% yoy, with the average price for a new car rising to $47,077, according to Kelly Blue Book. If the car was not expensive enough, energy prices registered a 29.30% increase from the year ago period with gasoline rising a whopping 49.60% yoy. Excluding food and energy, core CPI rose 5.50% from the year ago period – its biggest increase since February 1991. Some signs of price relief are starting to appear. Producer prices, which measure wholesale prices for goods and services, increased just 0.20% in December. That was down sharply from November’s 1.00% increase. Month-to-month, food and energy prices tumbled -0.60% and -3.30%, respectively. Price growth should continue to ease throughout 2022 as supply chains resume normal operations and consumer demand is likely to shift from goods back to services.
Traders had hoped Q4 2021 earnings season would serve as a positive catalyst for markets given that earnings are expected to rise 23.10% yoy. Banks are the first major group to announce each quarter, and with healthy economic growth and prospects of greater net interest spreads now that the Fed is starting to tighten, investors have been bullish on the sector. Unfortunately, the first round of reports was a disappointment. JP Morgan and Citigroup noted, among other items, substantial headwinds from rising costs (primarily rising wages), which prompted them to lower their 2022 outlooks. Unfortunately for the banks, the optics were made worse by having to announce during the same week that the CPI report hit a forty-year high and the Federal Reserve said that industrial production fell for the first time since September. We’re still very early into the earnings season, but for a market that was already concerned about inflation, this first round of reports underscored just how quickly rising costs can erode profitability. This will be a key theme keeping markets on edge as we progress through the remainder of the earnings season.
The Week Ahead
Our office and the markets will be closed on Monday, January 17th in observance of Martin Luther King Jr. Day. The Q4 2021 earnings season continues with reports from the consumer products, industrials, and healthcare sectors. U.S. economic news will be relatively light with existing home sales and housing starts being the highlights of the week. Overseas, China releases Q4 2021 GDP figures.
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In My Experience
In recognition of Buddy Ozanne’s 50th work anniversary, we are continuing to share some of the wisdom and insight that Buddy has accrued over the past five decades helping families achieve their financial goals. Below is another example of a real-life planning scenario that offers lessons for families – and for married couples in particular – that are still relevant today.
The Dos and Don’ts of Generational Wealth
Written by Buddy Ozanne
When it comes to wealth, many families spend lots of time earning it, spend some time creating plans to pass it down, and spend little or no time discussing those plans with loved ones and future generations. This understanding has guided my estate planning conversations with countless individuals and families. In the fall of 1989, I traveled from Dallas, TX to the Midwest for a first in-person meeting with potential clients, a married couple in their early 70s. For the purposes of this piece, I will refer to the clients as Mr. and Mrs. Miller.
Meet the Millers
Mrs. Miller was deeply interested in my perspective and my assessment of her estate documents. However, Mr. Miller was thoroughly convinced that his estate plan was completely “in order,” and in our initial phone conversation, he said, “I don’t know why I was referred to you. I already have my estate planned and the documents drafted by a prominent and well-respected estate attorney.” Once I arrived at their home, Mr. Miller reiterated that he really wasn’t sure that I could be of much help, and he re-told the story of how he and his wife had an excellent estate attorney and had given the attorney the instructions to leave everything they owned to their grandchildren. The attorney drafted wills that did precisely what was requested without consideration or explanation of the tax consequences. The couple left everything that they owned to each other, then directly to their grandchildren, effectively cutting their children out. Mr. Miller explained that his father-in-law had left his estate in this manner, skipping he and his wife, so he felt that their kids had plenty already.
Kill Them on Paper
Over the years, I have learned a technique to demonstrate the tax implications of this type of estate planning. We sometimes refer to it as “killing someone on paper” because it demonstrates the tax liability accrued by an estate when someone dies without a carefully prepared plan in place. I handed Mr. Miller a yellow legal pad and asked him to write down some figures. I then pulled out my federal income and estate tax tables and began to do some calculations. In 1989, the estate tax exemption was a mere $600,000. Once we applied income tax, estate tax, generation skipping transfer tax, and the excess accumulation excise tax to his large IRA (rolled over from a company profit sharing plan), the combined effective tax rate was more than 80%! When we reviewed the legal pad that showed the total estate and income tax amounts that would be due on their deaths under their current estate plan, they were both very concerned. Mr. Miller exclaimed, “Why, that’s way too much! My attorney didn’t show me these numbers!”
Mitigating the Tax Problem
We continued to discuss these tax implications, and it became clear that Mrs. Miller had never wanted her estate to skip over their two adult children. Mr. Miller shared that he thought they agreed on their plan. I do think the husband was well-intentioned and had misunderstood or misinterpreted what he believed to be he and his wife’s shared wishes. After the couple discussed both of their desires for their estate at length and in great detail, I shared with them that with a little planning, including a little inter-generational blended with some skip-generational planning, we can greatly reduce the potential tax liability. I added that if they included some charitable planning, they might be able to eliminate the tax altogether. This couple deeply loved their church as well as their children and grandchildren. The solution addressed all of their concerns and wishes and, more importantly, represented both of their desires.
The Solution
Following an extended planning session, we solicited an attorney to draft two trusts: one trust left the wife’s separate property in trust for her children for their lives, then continued for the grandkids’ lives following her husband’s death, and the other trust for Mr. Miller left the maximum amount without incurring estate or generation skipping tax for their grandchildren following his wife’s death. The couple also decided at that time to leave all of the taxable excess of their estate in a charitable lead trust which provided income to their church charities for a period of 20 years. At the end of the 20-year period, this charitable trust reverted to their kids’ and grandkids’ trusts. The future value of the charitable lead trust’s income stream was enough to eliminate the estate tax, even though the family (especially the grandkids) got the assets back following 20 years.
The Importance of Family Meetings
Once the family’s estate plan was completed, the couple hosted a family meeting where their estate attorney and I explained their plans, including their children’s benefits and responsibilities. Bringing the family together for productive conversations about the family’s wealth transfer plan began a regular schedule of family meetings which helped ensure the plan’s success. The wife was the family’s investor. She loved to do research on individual companies and consult with advisors. She did a great job of communicating the value of long-term investing. The husband was very frugal, and he did a good job of communicating the importance of good financial stewardship. Over the past three decades, we have conducted numerous meetings with three generations of Miller family members, both prior to and following the parents’ deaths. These meetings have fostered a deep understanding of the family’s values and expectations. And, after including their children in planning discussions, the father eventually amended his trust to provide income to their children for their lives and then for the benefit of the grandchildren, just like his wife’s trust.
The family’s plan has evolved to keep pace with ever changing estate planning laws and tax legislation. As the federal estate tax and generation skipping tax exemptions increased, the family was eventually able to do away with the charitable lead trust altogether and avoid the estate tax. This has allowed the children and grandchildren to engage in planning their own charitable intent.
Successful Multigenerational Planning
My colleagues and I firmly believe that good multigenerational wealth preservation can only be achieved when all members of the family are engaged in planning and informed about the plan’s structure and purpose. Both partners of a marriage should be willing to speak freely about their wishes and intents. I share with clients that any planning that does not include both spouses would be a waste of time for all parties. The non-participating spouse will likely not be happy with the structure of the estate plan and may request another meeting to review and make changes, or the non-participating spouse may refuse to sign the documents.
Another key to success in multigenerational wealth preservation is communication. Clients who are successful in transferring and preserving family wealth over multiple generations communicate their plans with their heirs. They communicate and celebrate what it took to accumulate their wealth. They communicate how to manage wealth and how to choose the right advisors in that endeavor. Heirs who have been prepared to inherit wealth may make some mistakes…we all do; however, preparation minimizes those mistakes and generally softens their impact. Over fifty years of estate planning experience has given me the insight to help our clients prepare their families to act as good stewards of their largess. And, our firm has endeavored to transfer our lessons and intellectual capital in wealth management to the next generation of management here at Probity Advisors.