The Margin of Safety Quarterly Spring 2024

 In Client Bulletins, News

A Look Ahead:

  • Investment Outlook & Portfolio Positioning
  • Estate Planning Beyond Estate Documents
  • War & The Markets
  • Firm News
  • Closing Thoughts


Market Recap

In the first three months of 2024, the U.S. economy remained resilient despite short-term interest rates sitting near 20-year highs. Noteworthy in the quarter was the continuing robustness in the labor market, stronger-than-anticipated corporate earnings, and a convergence of market participants’ aggressive forecast of rate cuts with the Fed’s own projections. Retail sales pulled back, but the trend remains positive.

These factors provided a supportive backdrop for stocks. The S&P 500 Index continued to reach new highs throughout the quarter, gaining a remarkable 10.6% in the three-month period. This would be 40% growth if the index were to keep up at this pace for the year. Large-cap U.S. stocks (S&P 500 Index) outperformed small-cap U.S. stocks (Russell 2000 Index), and growth stocks (Russell 1000 Growth) again beat value stocks (Russell 1000 Value).

Developed International and emerging-market stocks also posted gains but did not keep pace with the U.S. market. Developed International stocks (MSCI EAFE) gained 5.8%, while emerging-market stocks (MSCI EM Index) posted a modest 2.4% return. These returns would still be highly positive if they were to continue for the year with emerging markets potentially gaining 10% if they continued at the same rate.

Bond returns were mixed as the benchmark 10-year Treasury yield rose from 3.88% to 4.20%, with market expectations for rate cuts tempered in terms of timing and magnitude. In this rising-yield environment, the more interest-rate sensitive Bloomberg U.S. Aggregate Bond Index declined 0.8%. Credit performed relatively well in the quarter, as high-yield bonds (ICE BofA High Yield Index) were up nearly 1.5%.


Tax Corner

Hopefully everyone has either already filed their tax return for 2023 or filed an extension. However, since you are probably still in a tax mood, here are some planning items to think about for 2024 while we are still early in the year.

For those with earned income, consider making monthly contributions into IRAs or Roths. This makes these contributions easier to stomach than one large contribution at the end of the year. If you are self-employed, consider the same thing for your SEP IRA, Solo 401(k), or SIMPLE IRA. If you can max out your 401(k) from a cash flow perspective, do so as it will save you taxation either now or down the road depending on whether you are using the Roth or traditional option.

For charitable giving, cash is the least beneficial way of making a gift from a tax perspective. For those over 70, a qualified charitable distribution from your IRA is usually preferable. For those under 70, giving appreciated stock (either in combination with a donor advised fund (DAF) or without) is usually best. With a DAF, you can lump multiple years of giving into one and raise the chances that itemizing is more beneficial than taking the standard deduction.

For most of our clients, estate tax is unlikely to be an issue at this point. However, if your net worth is over $10,000,000 for a couple ($5,000,000 for a single person) or you project it to get there prior to your death, it is possible. In early 2025 the current estate exemption of roughly $25,000,000 will revert to those lower amounts if Congress does not take action. Stay tuned if you are in this bucket.

From an investment perspective, we try to reduce the taxable impact of your portfolio automatically. We do tax loss sales within your taxable brokerage accounts several times a year to reduce the tax impact of capital gains, or potentially eliminate it. The past year was a better year for stock markets, so we were not able to eliminate gains as extensively as we have in past years. We also position accounts for tax efficiency, placing fixed income (bonds) in IRAs as they are taxed at ordinary rates at time of distribution, while we place stocks in taxable accounts since they receive preferential tax rates on long term capital gains and dividends. We have also discussed with some of you sophisticated tax strategies related to rental properties and how to continue deferral of gains post sale through newer investment products. This can be particularly appealing for a low cash flow property with small basis as cash flow can be drastically increased and the gain can continue to be deferred, while reducing tax complexity and administrative burdens.

Our recommendation for tax conversations is that you would reach out to both us and your tax professional. It is often true that we may look at things from different perspectives than your tax professional and be able to provide insight into factors not considered.


Investment Outlook and Portfolio Positioning

Looking deeper into what has driven the resiliency of the markets one of the main drivers of this better-than-expected economic growth has been the continued strength of the U.S. consumer. The combination of robust job gains and steady real income growth has allowed consumers to continue spending despite higher rates. The strong consumer has also benefited corporate earnings. And after a decade of near-zero interest rates, companies are generally well positioned financially with balance sheets that are healthier than they have been in past tightening cycles.

Another factor for the markets strength has been the meaningful decline in inflation (CPI) over the past year, falling from 6% to just over 3%, though still above the Fed’s long-term target of 2%. Our expectation is that inflation will continue to trend lower over time, due in large part to shelter costs, which we expect to continue to moderate. However, inflation has been somewhat more stubborn at receding than expectations were earlier this year and that has led to a decrease in the expectations for additional rate cuts.

Economic growth in and of itself does not cause inflation, and ongoing modest economic growth is not a reason for the Fed to avoid cutting rates. However, persistent growth of around 2% does make it difficult to foresee aggressive rate cuts, and we’ve seen this reflected in the market’s expectations for the Fed Funds rate during the quarter. In the chart below, we see that at the beginning of the year, the market was anticipating six to seven rate cuts (shown in blue). But as of the end of March, the market’s expectations (shown in green) have tempered, and the consensus is for three rate cuts bringing the top end of the Fed Funds range to 4.75% at the end of 2024.

The market consensus was that the Fed would cut by 25bps in June, however that probability decreased based on stronger than expected inflation in March. This shows how quickly this expectation can change. In fact, some are now questioning whether the Fed may need to continue to raise interest rates. If this were to happen, then some of the increase in stock prices that we have seen may be given back. Even as of the writing of this letter on the 16th of April, we have already seen the S&P 500 pull back by almost 4%.

However, for now, U.S. economic data seems supportive of growth, not contraction. But the Fed’s ability to engineer a ‘soft landing’ of the U.S. economy with inflation converging to 2% and growth continuing seems to be getting harder and harder to pull off. On a positive note, if a recession does occur later this year, the Fed will have the ability to cut rates swiftly and meaningfully given the current rate level. When rates were near zero the Fed had to go to much more extraordinary measures to stimulate than they would need to now.

Our equity positioning continues to prefer value stocks instead of growth stocks as we believe growth stocks would be far more impacted by a market pullback. We believe that the next several years will be kinder to active stock picking and less kind to indexing. We are going to make some slight changes to our equity exposure in some models, reducing emerging markets in favor of developed markets and increasing our weighting to U.S. small caps slightly in most models. This change is incremental and is not representative of a belief that emerging markets are overvalued but with recent geopolitical issues we are taking a more conservative approach to overseas exposure for emerging markets.

When it comes to growth exposure, we like private markets for those that can meet the qualifications. These funds allow us to access companies that could one day be the new Microsofts or Googles of the world but at significantly lower entry points. Private equity has traditionally only been available to institutions and ultra-high net worth individuals, so we find the trend towards “democratization” of these markets encouraging.

For fixed income positions, we continue to believe that adding duration is a good practice at present. We believe that inflation is under control for now, and that short-term interest rates have peaked and will likely decline slightly over the course of the year. For corporate bonds, we do not foresee a near-term risk of a spike in default rates given the still-attractive corporate fundamentals. We continue to like private credit as an asset class and have been adding it to portfolios that are able to meet the qualifications. With yields on private credit in the 10-13% range, this far outpaces high yield bonds which are getting around 8% currently.

Beyond traditional stocks and bonds, we have also made small investments in real estate through private markets and infrastructure for various investors. These areas of diversification are meant to provide inflation protection, appreciation, and income with relatively low risk levels. Although the real estate market has been challenged recently as interest rate increases negatively affect property values, we believe that current valuations provide an attractive entry point. In real estate we prefer rental housing, industrial (warehouse), and data centers. We believe that all of these areas exhibit positive supply/demand dynamics.


Estate Planning Beyond Estate Documents

When most people think about estate planning, they think about the process of transferring assets in an efficient and tax friendly manner to the next generation. This is commonly also what an estate planning attorney will discuss. However, estate planning that does not go beyond simple wills, trusts, and beneficiary designations is often lacking when it comes down to it. Often missing are answers related to why something is being done, instead of just how to do it. For example, it is common to have a trust say something along the lines of “My spouse can access principal of my trust for health, maintenance, and support.” These are legal terms that carry weight within the law. However, what do they mean and how should a trustee interpret them? What if the spouse wants to move to a new, more expensive home, buy a boat, get a club membership? Is this included within the intent of the grantor?

This is where some form of additional document or videotape that expresses the intent of the person that has passed can be so important. This “document” can provide context for the decisions. If your good dishes are going to one grandchild while another inherits your antique clock, is it because you think the one grandchild will use the dishes to have parties and because you have noticed that the other always helped to wind the clock with his grandfather? Documenting the “why” behind these decisions can mean so much in terms of reducing conflict and increasing understanding at a time that is often difficult for families.

Could you imagine if your loved one has died and you find they have recorded a tape that describes what values they have found important, what they wish for future generations, what they would like to see preserved from the past, and what they want to make sure they are remembered for? This seems like it could provide such comfort, value, and could come to be one of the most treasured items of their legacy.

For those of you that would like more information on what this document/video would look like please reach out to us.


War and the Stock Markets

The song “War,” originally recorded by The Temptations in 1970 at the height of the Vietnam War, asks the question: “War, what is it good for?” to which the response is “Absolutely nothing.” While this song was not written as a direct response to how war affects the stock market, it could easily be reinterpreted for that cause. The chart below provides examples of conflicts and the losses they caused in the stock market. The quick takeaway is that they did not cause much of a reaction. The average reduction in the markets was 5% and the time to recovery was under two months.

We have had many clients question the potential effects in the market of a conflict between Iran and Israel. Modern stock markets are comprised of a huge number of factors influencing whether stocks will increase or decrease over a period. Like in other cases, we think valuation is the best judge of future performance, and we like to buy assets that are trading at a discount to their long-term value. We feel that this gives us margin of safety, which is why we title this newsletter as such – in case there are unanticipated events.


Firm News

As you may know, Melynda Rodgers joined the firm in February. Melynda joined us from Gries Financial Partners where she was a Director and assisted high net worth individuals with their planning. Prior to joining Gries, Melynda worked for Ullmann Wealth Partners for over seven years and assisted clients with various aspects of planning. Melynda has been coming up to speed quickly on client planning and has reached out to many of you. We believe that Melynda’s expertise in planning will be of a large benefit to the firm as she brings new perspectives on how to help you reach your goals. Melynda is particularly passionate about Special Needs planning and received the Chartered Special Needs Consultant® designation recently. If you know of friends or family that need help with this planning concern, then Melynda can be a great resource for them.

As the investment advisory business continues to evolve, we are investigating ways to bring increased efficiency to what we do so that we can spend more time assisting you with your investment and planning needs. We have rolled out several of these over the past several years including Calendly for scheduling meetings, PreciseFP for gathering information from you more efficiently, and FP Alpha that assist us in the background with analyzing various estate and insurance documents. Feedback from these changes has been very positive. We have been working on an evolutionary change to the way we assist you that we hope to be able to discuss with you more in the next few months. Stay tuned!


Closing Thoughts

We are hugely grateful and humbled that you have selected our firm to assist you with the task of helping you reach your goals. We take this duty seriously and try to provide you with the very best advice that we can to do so. Sometimes this means difficult conversations, guiding you in making hard choices to prioritizing your goals. However, the greatest reward to us is when we get to see someone reach the goal that they have worked so hard for.

If there are others that you think could benefit from our planning and investment approach, we would welcome the referral of them to us. We believe that we are the exception to how most advisory firms operate in several ways, from our planning process and fee-only approach to our use of private markets. We want to be on the leading edge of wealth management firms.

Thank you for your continued trust and confidence.



Certain material in this work is proprietary to and copyrighted by iM Global Partner Fund Management, LLC and is used by River Capital Advisors with permission. Reproduction or distribution of this material is prohibited, and all rights are reserved.

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