Author: CIG Capital Advisors

Commentary:

The performance ratio of the S&P 500 Information Technology Sector to the S&P 500[i] (the blue line on the above chart) has hit an all-time high of 0.66. The ratio’s previous all-time high was set in March 2000 at 0.64. As we previously discussed in What If the Bubble Bursts?, from March 27, 2000 (a) to October 9, 2022 (b) the S&P 500 (black line) fell -49% and then it took over 7 years to recover its losses after the peak. This same ratio hit 0.64 again on December 27, 2021 (c) and was followed by a -25% drawdown in the S&P 500 through October 10, 2022. (d) Now, as of May 15, 2023, this important ratio has hit a new all-time high of 0.66. (e)[ii] Will history repeat? Are we currently in a second massive technology bubble? No one knows for sure – but we are very cautious.

The rally thus far year-to-date has been narrow and concentrated in a few names. Six S&P 500 stocks – Apple, Microsoft, Nvidia, Alphabet, Amazon, and Meta – have contributed 90% of the gains of the overall index year-to-date through May 18, 2023.[iii] Five of these stocks are working on incorporating artificial intelligence (A.I.) into their business models and product offerings. While A.I. could be disruptive in the long run, the euphoria in anything A.I.-related reminds us of 1999, when many of the dot-com stocks soared in value with the internet as we know it now was still in its infancy.

Consequently, we continue to attempt to optimize our client’s exposure to the information technology sector in our pursuit of navigating our clients’ investments through these potentially turbulent market conditions. It is impossible to predict where these developments will lead, of course, but periods of upheaval can create opportunities for transformative change. We stand ready to possibly increase our allocation to domestic equities should the market rally broaden out to other sectors that have not kept up with the mega-cap growth stocks that have led year-to-date thus far. If we experience a significant market drawdown, then great opportunities could exist in the market which we would endeavor to evaluate and potentially participate in.

While volatility has moved lower over the course of 2023[iv], we do not expect that to persist for the remainder of the year. Therefore, we continue to stay the course of risk-balanced investing. We remain focused on striking the right aggressiveness versus defensiveness in client portfolios given the evolving uncertainty in the markets, the economy, and geopolitics.

Please reach out to Brian Lasher (BLasher@cigcapitaladvisors.com), Eric T. Pratt (EPratt@cigcapitaladvisors.com) or the rest of the CIG team if you have any questions.

Commentary:

The U.S. Dollar, as measured by the U.S. Dollar Index, reversed its gains in February and fell -2.5%[ix] in March 2023 and contributed to gains in gold and international equities – both are dollar-sensitive investments. Emerging markets equities, represented by the MSCI Emerging Markets Index, gained +3.0%. The S&P 500 Index advanced +3.7%, recovering the prior month’s losses and Fixed Income, as measured by the Bloomberg U.S. Aggregate Bond Index, gained +2.5%.[x]

Our two flagship strategies, CIG Dynamic Growth and CIG Dynamic Balanced, have captured a majority of their respective benchmarks’ gains during March 2023 and Q1 2023.

• The CIG Dynamic Growth Strategy Composite participated in 96% of the upside of the Growth Benchmark during March 2023 and has captured 69% of the Growth Benchmark’s return on a net basis year-to-date.[xi]
• Similarly, the CIG Dynamic Balanced Strategy Composite participated in 94% of the upside on the Balanced Benchmark during March 2023 and has captured 77% of the Balanced Benchmark’s return, also on a net basis year-to-date.[xii]

When we measure these strategies’ returns from January 1, 2022 through March 31, 2023, we were able to avoid 74% of the Growth Benchmark’s losses[xiii] and we were able to avoid 85% of the Balanced Benchmark’s losses.[xiv] As always, past performance is not indicative of future performance and is no guarantee of future results. Like many investors, we are happy to be up in the first quarter of 2023 after a difficult 2022.

Last month, we highlighted in our update four possible tail risks. Each day, we are trying to make sense on behalf of clients the rapidly changing market, including:

• We are encouraged that inflation, as measured by the Consumer Price Index, has fallen from 9.1% year over year in June 2022 to 5.0% in March 2023.[xv] Inflation is still 2.5x the Federal Reserve’s stated target of 2%.[xvi]
• If Banks were to increase rates paid on deposits to compete with a Federal Funds rate of 4.88%, it would cost approximately $839 billion annually[xvii], effectively wiping out 86% of the banks’ net interest income, which as of fourth quarter 2022 was $966 billion.[xviii] Lower net interest income will likely greatly affect the profitability of small to mid-sized banks and may influence them to tighten their lending to businesses.
• $1.4 trillion of U.S. Commercial Real Estate (CRE) loans mature by 2027, including $270 billion due this year. The availability rate of office space – vacant offices plus currently leased space that is not being renewed or listed for subleasing – hit an all-time high of 16.4% at the end of Q1 2023.[xix] As property values fall and more borrowers are defaulting on their loans, the CRE market could be the next big concern for banks, especially the smaller ones. Overall, banks represent 54% of the $5.7 trillion CRE market.[xx]

The world we live in is rapidly changing. Increased tensions over Ukraine and Taiwan raise the possibility of direct conflict between nuclear superpowers. We are continuing to deal with the aftershocks of the deadliest global pandemic in recent history. Climate change is rapidly impacting our environment.

Instead of some new perspective that clarifies all possible scenarios and a clear path forward, we are presented with two opposing visions of the future. One, a downside scenario where stocks may suffer large drawdowns and two, a progressive narrative centered around hopes of technological gains using artificial intelligence, or A.I. Both views are expressed in the stock market right now. On the progressive side, the rally thus far year-to-date has been narrow and concentrated in a few names. Twenty S&P 500 stocks have gained $2.05 trillion in market value year-to-date through March 31. This accounts for 87% of the S&P 500 Index’s $2.36 trillion of gains year-to-date through 3/31/2023. Four of these stocks – Microsoft, Alphabet, Meta and Amazon, are working on incorporating A.I. into their business models and product offerings and then there’s Nvidia that makes processing chips that power A.I., gaining +90% year-to-date through 3/31/2023.[xxi] On the other hand, many other stocks have underperformed the index. UBS has calculated that excluding the gains in these mega-cap growth stocks – the S&P only rose +1.4% in Q1 2023.[xxii] The euphoria in anything A.I.-related reminds us of 1999, when many of the dot-com stocks soared in value with the internet as we now know it in its infancy. As we discussed in November 2021 in What If the Bubble Bursts, a lot of the returns of those companies were wiped out from 2000 to 2002. Gold and many consumer staple stocks provided positive returns during the very negative period.[xxiii]

We persist in our pursuit of navigating our clients’ investments through these turbulent market conditions. It is impossible to predict where these developments will lead, of course, but periods of upheaval can create opportunities for transformative change. We stand at the ready to possibly increase our allocation to domestic equities should the market rally broaden out to other sectors that have not kept up with the mega-cap growth stocks that have led year-to-date thus far. If we experience an overall market correction, then tremendous opportunities could exist in the market which we would endeavor to evaluate and potentially participate in.

We continue to stay the course of risk-balanced investing – take enough risk at this part of the market cycle to reach your goals but not much more. We remain focused on striking the right aggressiveness versus defensiveness in client portfolios given the evolving uncertainty in the markets, the economy, and geopolitics.

Please reach out to Brian Lasher (BLasher@cigcapitaladvisors.com), Eric Pratt (EPratt@cigcapitaladvisors.com) or the rest of the CIG team if you have any questions.

Commentary:

The U.S. Dollar, as measured by the U.S. Dollar Index, strengthened +2.9%[ix] in February 2023 and contributed to losses in gold, crude oil, and international equities – all are dollar-sensitive investments.[x] Emerging markets equities, represented by the MSCI Emerging Markets Index, lost -6.5%. The S&P 500 Index fell -2.4%, and Fixed Income, as measured by the Bloomberg U.S. Aggregate Bond Index, fell -2.6%.

Until the recent bank failures, markets appeared relatively calm on the surface, but many additional outsized potential risks remain lurking just below. In our risk-balanced approach to investing, we seek to avoid the big risks that could be detrimental to our clients’ financial well-being. Like a sherpa guiding a group of climbers up the mountain, we do all we can to avoid the hidden crevasse where, if one is not extremely diligent and cautious, a wrong move could lead to a very negative outcome.

We call these “very negative outcomes” tail risks which are defined in the industry as the chance of a large loss due to a rare event. Noted mathematical statistician, investor, and writer Nassim Nicholas Taleb has described this risk as a Black Swan – “a highly improbable event with three principal characteristics: It is unpredictable. It carries a massive impact, and after the fact we concoct an explanation that makes it appear less random and predictable than it was.”[xi] In addition to looking out for more instability in banks, we are currently keeping a diligent eye on four different areas with low probabilities but have the potential for some very troublesome outcomes – Option Market Risk, Higher Interest Rates, Student Loans and Geopolitical Risks.

Option Market Risk
The daily value of U.S. equity options set to expire at the end of the trading day, so called “zero date to expiry options” (0DTE), has suddenly risen to about $1 trillion according to JPMorgan strategist Mark Kolanovic. These extremely short-term options are highly speculative bets on stocks and now make up over 40% of the total dollar volume for S&P 500 listed stocks – three years ago they were only 15% of total volume.[xii] JPMorgan analysts Peng Cheng and Emma Wu wrote in a note that the estimated market impacts from unwinding of 0DTE options quickly could pose a potential risk to market stability and result in a decline that could eclipse the Black Monday Crash of 1987, where the S&P fell -20.5% in a day. According to JPMorgan, if the S&P 500 fell -5% in five minutes, it could trigger $30.5 billion in 0DTE option trading that could add an additional -20% to the index’s decline. If the S&P 500 fell between -1% and -5% in five minutes, it could translate to an additional -4% to -8.1% decline.[xiii] In 1987 it was portfolio insurance products that exacerbated the market’s decline.[xiv]

Higher Interest Rates
The average 30-year fixed mortgage rate was 7.06% as of the week ending March 3, 2023.[xv] One year ago, a home buyer could borrow at 3.76%.[xvi] A current home buyer with a $200,000 mortgage will have a monthly payment of $1,339 versus $927 if he purchased the house a year ago, or $4,944 more per year![xvii] Federal Reserve Chairman Jerome Powell in his testimony to the Senate Banking Committee on March 7 said that interest rates are “likely to be higher” than previously anticipated.[xviii] How will higher mortgage rates affect the critical March through June season for the housing market, when 40% of existing home sales typically occur for the year?[xix]

Student Loans
In March 2020, COVID-19 lockdowns negatively impacted the U.S. economy. Student loan payments were suspended and the government paid the interest on the deferred student loans. In November 2022 these deferrals were extended for the eighth time into the summer of 2023. The Supreme Court is currently hearing lawsuits challenging a plan by the Biden administration to cancel up to $20,000 debt per student. Repayment of student loans is now scheduled to resume either 60 days after the lawsuits are resolved, or 60 days after June 30, 2023, whichever comes first. The deferral could stretch into August, or it could end sooner if the Supreme Court acts swiftly.[xx] 10.75% of student loans were 90+ days delinquent before the deferral program began. In Q4 2022, this percentage has plummeted to only 0.87%. At the end of 2022 there was $1.6 trillion of student loan debt outstanding.[xxi] According to Forbes, the average monthly student loan payment is $393.[xxii] What will happen if borrowers need to resume monthly loan payments? Will delinquency rates soar back to pre-pandemic levels and lead to over $160 billion of student loans 90+ days delinquent?

Geopolitical Risks
Russia: We believe the fragile state of international affairs continues to be underappreciated by the markets. February marked the one-year anniversary of Russia invading Ukraine. Billions of dollars of military aid continue to be sent to Ukraine as the war rages on. Russia has warned NATO members of the threat of a major escalation if heavy weapons such as tanks and long-range missile systems are deployed to Ukraine. In January, President Biden announced he would send 31 M1 Abrams tanks to Ukraine. On February 23, Army Secretary Christine Mormuth said, “We’re looking at what’s the fastest way we can get the tanks to the Ukrainians.” Mormuth continued, “None of the options that we’re exploring are weeks or two months. There are longer timelines involved, but I think there are options that are less than two years, less than a year-and-a-half.”[xxiii] Will Ukraine be able to continue to defend against Russia’s attacks without tanks, and how will Russia respond once NATO tanks are on the battlefield? Currently the risk of the Ukraine/Russian conflict spreading to NATO member countries is low, but it would likely offer a very negative outcome should it occur.

China: China/U.S. relations worsened after the United States shot down a Chinese spy balloon on February 4. U.S. Secretary of State Antony Blinken warned China on February 28, “We will not hesitate, for example, to target Chinese companies or individuals that violate our sanctions, or otherwise engaged in supporting the Russian war effort.”[xxiv] On March 7th, In his first public comments as China’s new foreign minister, Qin Gang said, “If the U.S. does not hit the brakes but continues to speed down the wrong path, no amount of guardrail can prevent derailing, and there will surely be conflict and confrontation.” Qin also defended China’s friendship with Russia, saying the ties between Moscow and Beijing “set an example for global foreign relations”. He continued, “With China and Russia working together, the world will have a driving force. The more unstable the world becomes the more imperative it is for China and Russia to steadily advance their relations.”[xxv] In early 2022, Beijing ordered a comprehensive stress test to study possible implications of Russian-style sanctions on its economy.[xxvi] China bought 77 tons of gold between November 2022 and January 2023, its first reported purchases since 2019. These purchases were likely made to move out of U.S. dollars after the SWIFT payment system was used to impose sanctions on Russia.[xxvii] Is China preparing for an eventual invasion of Taiwan? The Carnegie Endowment for International Peace reported that some in the U.S. intelligence community believe an attack could come as soon as January 2024, around the time of Taiwan’s elections.[xxviii]

Market history has taught us to be very careful. We are focused on illuminating potential blind spots such as those above as we attempt to manage the risks of the market in our efforts to protect and grow clients’ assets. We scenario plan – we don’t forecast the market – meaning we are cognizant of the possibility of both continued upside and significant declines.

We are hopeful that none of the above risks come to fruition, but we are conscious of them and are watching closely as events unfold. We continue to have an overweighted allocation to gold and gold miners in our strategies as worsening geopolitical risks, inflation and possible longer-term risks of stagflation make gold attractive to us. Overall, we continue to stay the course of risk balanced investing – take enough risk at this part of the market cycle to reach your goals but not much more. We remain focused on striking the right aggressiveness versus defensiveness in client portfolios given the evolving uncertainty in the markets, the economy, and geopolitics.

We would welcome the opportunity to connect with you via voice or email to discuss how active oversight of market and economic conditions could protect your portfolio during uncertain times. Please reach out to Brian Lasher (blasher@cigcapitaladvisors.com) or Eric T. Pratt (epratt@cigcapitaladvisors.com).

Commentary:

2022 proved to be a difficult year for many investors with U.S. equities, as measured by the S&P 500 Index, down -18.3%, international equities, represented by the MSCI EAFE Index, down -14.0%, and Fixed Income, as measured by the Bloomberg U.S. Aggregate Bond Index, down -13.0%. Our CIG Dynamic: Growth Strategy Composite avoided 59% of the growth benchmark’s return while the CIG Dynamic: Balanced Strategy avoided 65% of the balanced benchmark’s return.[ix]

How did we outperform in such a difficult year? Active Management. We underweighted U.S. equities, especially the technology sector which fell -28.2%[x]. We overweighted international equities, which outperformed U.S. equites. We underweighted fixed income, which offered equity-like losses in a bad year. Most importantly, we overweighted alternative investments which included a long/short fund that gained +49.9% in a down year.[xi]

In his book Think Again: The Power of Knowing What You Don’t Know, noted Wharton business school professor and thought leader Adam Grant discusses the scientist’s frame of mind – “doubt what you know, be curious about what you don’t know, and update your views based on new data.”[xii] As we turn the page on 2022, here is an overview of our thinking throughout the past year we navigated:

“Don’t Fight the Fed” (December 14, 2022)
We explored what happened after the Fed Funds Rate exceeded the yield on a 10-year U.S. Treasury bond which is what just occurred in November 2022. In three modern cases, it wasn’t good.

Are We Experiencing Another Bear Market Rally? (November 14, 2022)
In our opinion, the stock market is still overvalued based on historical measures. The charts suggested a Bear Market Rally which seems to be unwinding now.

What Matters Now: Active Management and Alternative Assets (October 18, 2022)
Active Management and the use of alternative asset classes allowed CIG’s two largest investment strategies to outperform in 2022 their respective benchmarks.

Pain Points: What Can Be Learned; What Can Be Done? (September 12, 2022)
The theme of learning continued, with active management and possible strategies and implementations to relieve pain as we headed deeper into the stock market lows of the year.

Think Different (August 16, 2022)
Using Apple’s 1997 advertising campaign, we highlight the wisdom of Howard Marks, the legendary investor, “unconventional behavior is the only road to superior investment results, but it isn’t for everyone. In addition to superior skill, successful investing requires the ability to look wrong for a while.”[xiii]

Quantitative Tightening: The Fed, its Tools and Policies (July 29, 2022)
“Will the Fed do what they say they would and reduce their balance sheet?” We continue to monitor the Fed’s balance sheet to see its progress and test our thesis that they will.

Stagflation – Is a Perfect Storm Forming? (June 29, 2022)
How the economy may be heading toward a period of stagflation and discussed how to be careful ahead of a possible period of no growth and high inflation.

The Choice for Today’s Investor: Red Pill or Blue? (May 17, 2022)
A homage to “The Matrix” and whether investors will wake up to how equity valuations are still expensive and equity duration remains historically high.

Prudent Risk Management is Prudent Investment Management (April 19, 2022)
How a differentiated view and alternative assets can add value in difficult markets.

Uncertainty About How Much Risk You May Be Taking Is a Risk unto Itself (March 14, 2022)
Do you know what hidden risks may be buried in your portfolio? Interestingly, later in 2022, investors began finding out.

We believe we got many aspects of the market right in 2022 and feel investors benefited in the portfolios that we manage. But “the first rule of the Dunning-Kruger club is you don’t know you’re a member of the Dunning-Kruger club.”[xiv] Unfortunately, the investment markets have a punishing way of letting you know when your confidence is greater than your competence.

As “scientists” of the investment markets, we would appreciate you telling us where you feel we got it wrong as we begin 2023 together. Please reach out to Brian Lasher (blasher@cigcapitaladvisors.com) or Eric T. Pratt (epratt@cigcapitaladvisors.com) or share a dissenting opinion via voice with either of us at (248) 827-1010.

Commentary:

Domestic stocks continued October’s gains with the S&P 500 gaining +5.2% in November.[ix] Fixed income advanced +3.7% as measured by the Bloomberg U.S. Aggregate Index[x], as the yield on the 10-Year U.S. Treasury bonds fell -0.37% to 3.70% on November 30.[xi] Gold gained +6.7%[xii], International Equities in developed markets gained +11.3%[xiii], and Emerging Market Equities soared +14.8%[xiv], as the U.S. Dollar Index fell -4.9%.

Equities have benefited over the past two months from longer-term interest rates, as measured by the yield on the 10-Year U.S. Treasury bond, falling from their recent peak of 4.33% on October 20, to 3.41% on December 7.[xv] Investors appear to be encouraged by the September and October Consumer Price Index (CPI) reports that showed the rate of inflation has decelerated on a month-over-month basis (i.e., CPI was 8.2% in September and 7.7% in October).[xvi] Despite CPI remaining at 7.7% over the past year[xvii], some feel that the Federal Reserve has already raised rates too much and will need to cut rates as early as next year to keep the economy out of a recession.

“Don’t fight the Fed”, coined in 1970 by Martin Zweig, a finance professor and famed investor, is a mantra that suggests investors should align their investments with the current monetary policies of the Federal Reserve; that not doing so imperils investors’ portfolios. On November 30, Federal Reserve Chairman Jerome Powell spoke at the Hutchins Center on Fiscal and Monetary Policy, Brookings Institution, in Washington, D.C. In his speech, Powell noted, “It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.” Powell continued, “The timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level. It is likely that restoring price stability will require holding policy at a restrictive level for some time.”[xviii]

Investors appear to be “fighting the Fed” as long-term bond yields continue to fall even as short-term rates like the Federal Funds Effective Rate (Fed Funds), an overnight interest rate, are moving higher. In a normal (or less abnormal) world, short-term debt has a lower yield than longer-term debt of the same quality (i.e., it costs more — the interest rate — to borrow for a longer time). On rare occasion, short-term debt has traded at higher yields than long-term debt — this is called an inverted yield curve. Even rarer is when the Fed Funds is at a higher yield than the 10-Year U.S. Treasury bond, which is what just occurred in November 2022.

Let’s explore what has happened after the Fed Funds Rate (blue line) exceeds the yield on a 10-year U.S. Treasury bond (red line), as shown in the following chart:

Source: fred.stlouisfed.org

• May 2000. Stocks traded lower for two years; the dot-com bubble burst; and the U.S. economy entered a recession.[xix]
• July 2006. A year later, Bear Stearns failed; the housing bubble began to burst; and the 2007-2008 Great Financial Crisis sent the U.S. economy into a deep recession.[xx]
• Spring 2019. A year later, COVID-19 shut down the word economy; stocks fell; and the U.S. economy entered a brief recession.[xxi]

Perhaps inflation will drop to the Federal Reserve’s 2% goal and they will be able to engineer a soft-landing for the economy. Perhaps not. Regardless, as illustrated in the above chart, be careful what you wish for: markets and the economy suffered initially each of the last three times the Fed started cutting rates.

As we maneuver through these difficult conditions, we continue to apply our disciplined approach to Asset Management. Our CIG Dynamic Growth Strategy composite was able to capture 85% of the upside of the growth benchmark during November 2022 while year-to-date through 11/30/2022, it has avoided approximately 57% of the losses of the growth benchmark. Our CIG Dynamic Balanced Strategy captured 79% of the upside of the balanced benchmark during November 2022 while year-to-date through 11/30/2022, it has avoided approximately 65% of the losses of the balanced benchmark.[xxii]

We would welcome the opportunity to connect with you via voice or email to discuss how active management could protect your portfolio and capture opportunities when other investors are “fighting the Fed”.

As we enter the holiday season, many naturally turn their thoughts to charitable giving and yet, for the first time in nearly two decades, only half of U.S. households donated to a charity, according to a study from 2021 that is published every other year by Indiana University’s Lilly Family School of Philanthropy[i]. In the wake of the COVID-19 pandemic unemployment and food insecurity soared. In 2021, 53 million people turned to food banks and community programs for help putting food on the table, according to Feeding America[ii].

Taxpayers have until the end of the year to meet IRS deadlines, take advantage of tax rates that are locked in and qualify for charitable vehicles that are currently in place. There are two strategies they may want to consider: charitable lead annuity trusts and donor-advised funds. Note: these strategies tend to work best for those who can afford to designate a proportion of their income to charity on an ongoing basis.

An Under-the-Radar Option
A charitable lead annuity trust is a philanthropic option that’s a bit under the radar. It can be a good fit for those who have recently received a large influx of cash from, for example, selling a business or investment. It’s also an option for those who haven’t been able to deduct as much they’d like from their taxes.

The trust allows a donor to give cash, stock or real estate to a trust while offsetting income tax in the current year and potentially future estate taxes.

Even Jacqueline Kennedy Onassis included a charitable lead trust in her will, perhaps attracted by this benefit: Whatever assets are left in the fund at the end of the fixed term go to the donor’s beneficiaries tax-free.

A huge reason charitable givers should think about this kind of trust now: the lower the starting interest rate, determined by Section 7520 of the IRS code, the more the donor and his or her beneficiaries may benefit.

No Double Dipping
An upfront tax deduction and the ability to reduce estate and gift taxes — as well as the potential to pass on assets to heirs — make charitable lead trusts potentially very appealing.

But there are caveats. The funds in the trust are subject to investment management risk. After the initial tax deduction, donors can’t take any more deductions. No double dipping. Also, any capital gains or losses inside the trust flow back to the donor.

Charitable lead annuity trust are very complex vehicles. In addition to consulting with attorneys and accountants, it’s critical to work with a financial adviser to make sure any use of the trust is part of a holistic plan that aligns with your overall goals and interests.

Calling the Shots
Donor-advised funds (DAFs) are another attractive option for those who may have had a windfall this year or a bump in income. DAFs are a viable alternative to writing a check directly to a qualified organization or, for those with substantial wealth, starting a private charitable foundation.

Nonprofit divisions of financial service companies and other third parties, such as a community or church group, administer and legally control donor-advised funds. But as the name implies, individuals or families who set up the funds retain the ability to suggest or advise on where the funds should go.

The donors retain the ability to suggest or advise the donor on fund distributions.

Donors designate which IRS-designated 501(c)(3) charities receive money from the fund. They can change which organizations receive money and how much they get as often as they want.

What’s more, DAFs can be more attractive than family foundations because donors don’t have to worry about legal and administrative fees and can start one with as little as $5,000.

Any gift for the fund is an immediate tax deduction and the donor isn’t required to distribute it immediately. If you’re unhappy with the way one charity is operating, you can switch the distribution to one you like better. The donor calls the shots.

The tax benefits of a donor-advised fund are similar to contributions to religious institutions, colleges or public charities. Taxpayers who itemize can write off their cash donations up to 50% of the adjusted gross income. Those donating stock, real estate or any other asset that has appreciated can write off up to 30% of adjusted gross income. The unused amount can be carried forward up to five more years to be used as a deduction against income.

DAFs can serve as an appealing tax strategy for someone holding highly appreciated stock. If you were lucky enough to buy 100 shares of Apple (AAPL), 1.80% in 2008, for example, you can claim the current price of the stock as your tax-deductible donation. Meanwhile, the fund sells the stock and keeps the proceeds, but you don’t have to pay capital gains tax. In that way, you optimize your financial liabilities and make a powerful gift to charity at the same time.

People do need to keep in mind that once a donation is made to a DAF, it’s a completed gift. There’s no going back.

How Much in Benefits?
The tax benefit depends on your effective tax rate. For philanthropic options like DAFs, the benefit is not necessarily how much more you get in tax savings today, but the control you maintain over your donation.

And in the case of a charitable lead trust, it’s the ability to potentially retain some of your money down the road in the form of a tax-free payment to an heir or a beneficiary when the term of the trust runs out.

For both these strategies, financial advisers play a crucial role.

They will — or should — have a comprehensive plan for you and can identify whether the strategy is appropriate. Does it make sense for you or not?

Advisory firms will walk you through the financial planning process to make sure the tax or philanthropic option is truly viable.

You never want a complex strategy involving significant assets to be a one-off, where you’re just trying to get an edge on your taxes. You have to know how it affects the other pieces of your overall plan.

Commentary:

Domestic stocks bounced in October, with the S&P 500 gaining +8.1% after September’s -9.2% drawdown.[ix] Fixed income lost -1.3% as measured by the Bloomberg U.S. Aggregate Index.[x] International Equities in developed markets gained +5.4%[xi], while Emerging Market Equities lost -3.1%.[xii]

We believe it is important to zoom out to gain a greater perspective and look at the journey the stock market, as measured by the S&P 500, has taken since early-2020 through to early-November 2022, focusing on several timeframes in the chart below. The market was at an all-time high in February 2020, (A), just before Covid-19 lockdowns shook the global economy. The market then fell 33% until it bottomed out on March 23, 2020, (B). The market then steadily rallied to a new all-time high from the Covid-19 low to January 3, 2022, (C), as central banks worldwide intervened and provided massive liquidity through quantitative easing and low interest rates. Ever since the market hit its all-time high in early-January of this year, it has traded in a channel of successively lower highs and lower lows.[xiii]

Is it possible we are currently experiencing the third Bear Market rally since the all-time high in January 2022? Bear Market rallies have been defined as significant counter trend recoveries that can last as briefly as a few weeks to as long as several months before the market reverses course to a new low. The chart below serves to illustrate the concept of a Bear Market rally.

Source: Barchart.com

While we are encouraged by the stock market’s resilience seen from October into early-November, equities are historically expensive. The total market capitalization of U.S. stocks currently is 153% of U.S. gross domestic product (GDP), almost the same level as the 157% dot-com peak in March 2000, which was right before that bubble burst.[xiv] One overvalued stock, for example, is Apple, Inc. (AAPL). Apple’s stock soared +8% after it reported its recent quarterly earnings results as being slightly better than expected. Apple beat Wall Street analysts’ earnings expectations because of its iMac sales while both its services and iPhone sales disappointed. Apple CEO Tim Cook explained that “silicon-related wafer supply constraints were not significant in the quarter” (microchip shortages ended), and it allowed the company to satisfy back orders and “fill the channel” at resellers and retailers. Between 2008 and 2016, Apple’s price-to-earnings ratio was in a range of 10 to 17 and its compounded annual earnings per share growth rate over that same period was 30%.[xv] Now, it trades at more than 24 times earnings, with analysts expecting only 3% growth in 2023![xvi] Many other technology stocks are similarly overvalued on a historic basis.

We reduced exposure to technology stocks in October in our actively managed strategies before earnings were announced and just recently added back technology exposure in three targeted areas that are all down significantly from their highs: cloud computing, semiconductors, and cyber security.

Year-to-date (through to 10/31/2022), our CIG Dynamic Growth Strategy composite has avoided approximately 44% of the losses of the growth benchmark, and the CIG Dynamic Balanced Strategy has avoided approximately 59% of the losses of the balanced benchmark.[xvii]

We would welcome the opportunity to engage with you — via voice or email — to discuss your questions, and market challenges and opportunities, as well as the benefits of active investment management.

The FOMC raised short-term interest rates, known as the federal funds rate, by 0.75% to 3.25% on September 13 and signaled that they expect the rate to reach 4.6% in 2023. This suggests that investors likely won’t see a rate cut next year.[i]

Stocks suffered their first three-quarter losing streak for the S&P 500 and NASDAQ since the Great Financial Crisis in 2009.[ii]

Many traditional asset classes have suffered large drawdowns this year as evidenced by year-to-date returns through September 30, 2022:

Commentary:

U.S. equities, as measured by the S&P 500, were up +9.2%, the best month since November 2020. International Equities were up +5.0%[x]. Fixed income gained +2.4% as measured by the Bloomberg U.S. Aggregate Index.[xi] Gold fell -2.3%[xii] and crude oil lost -6.8%[xiii] as the U.S. Dollar Index gained +1.3%.[xiv]

On Wednesday, July 27, the Federal Open Market Committee raised the Federal Funds Rate (the interest rate at which depository institutions trade federal funds [balances held at Federal Reserve Banks] with each other overnight) by +0.75% to a range of 2.25% to 2.50%.[xv] During the press conference that followed the rate announcement, Federal Reserve Chair Jerome Powell said the Fed had already reached a “neutral” level of interest rates—one that neither boosts nor restricts economic activity. The S&P 500 gained +3.8% from the start of Powell’s press conference at 2:30p.m. July 27 through the close on July 29.[xvi] Many market observers attribute the post-FOMC meeting rally to Powell’s “neutral” comment. Has the Fed already done the heavy lifting? We think not and believe we are not alone in this thinking. Former Treasury Secretary Lawrence Summers said on Wall Street Week, “Jay Powell said things that, to be blunt, were analytically indefensible,” and “There is no conceivable way that a 2.5% interest rate, in an economy inflating like this, is anywhere near neutral.” Mohamed El-Erian, Chief Economic Adviser to Allianz SE and President of Queen’s College, said that “the zip code for neutral is above where we are now.”[xvii]

We have illustrated below just how far behind the curve the Fed currently is in its fight against inflation. In the previous seven tightening cycles, the Federal Reserve raised the Fed Funds Rate to a level higher than the inflation rate, as measured by CPI at that time, to bring prices down. As recently as April 2019, the effective Fed Funds Rate, the volume-weighted median rate, was 2.4% while CPI was up +2.0% year-over-year.[xviii]

July 2022 CPI was up +8.5% year-over-year, while the effective Fed Funds Rate is only 1.68%.[xix] We find it incredulous that with over four times the amount of inflation now versus in 2019 and with the effective Fed Funds Rate lower than it was, that the Fed is at “neutral”. The Fed may very well need to raise short-term interest rates a lot more to combat inflation. If it does, we believe stocks will have a sell off.

Having stock, interest rate, and other views that diverge from the collective wisdom of the market can be quite rewarding. In 1997, Apple Inc. launched the “Think Different” advertising campaign. The slogan was launched shortly after Steve Jobs returned to Apple to counter IBM’s slogan at the time, “Think”, a campaign for their ThinkPad.[xx] Apple’s market capitalization in 1997 was around $2.3 billion[xxi] and grew to $2.6 trillion at the end of July 2022.[xxii] IBM’s market cap in 1997 was around $86 billion[xxiii] and only grew to about $119 billion at the end of July 2022.[xxiv] “Think Different” has been very rewarding for Apple—not because of the slogan, but their strategies. Over that 25-year period, excluding dividends, an investment in Apple grew over +100,000% versus IBM’s +38% growth. Howard Marks, legendary investor and co-founder of Oaktree Capital Management, recently wrote a memo to investors titled, I Beg to Differ.[xxv] Marks’ memo highlighted, among many other things, how active investing and contrarian investing are some of the few ways that investors can achieve better returns than the market. In other words, think different.

Marks’ memo has fortified our investment committee’s approach to the entire investment decision-making process. Here we list nine items that we live by each day.

1. Most investors will have average returns. They may be good or bad, but they will be average.

2. If you are happy with average returns, buy index funds and allocate the same as the respective benchmark.

3. To be above average, one must stray from consensus behavior and do something different. One must over/underweight sectors, asset classes and markets. This is “active investing”.

4. Active investing carries both the risk of below average returns and the potential reward of above average returns.

5. When one departs from the herd of passive index investing, they need to use “second-level thinking” to dig deep to develop their investment strategy.

6. Second-level thinking, as Marks describes it is different, deep, convoluted and complex. It takes into account questions, such as:

a. What is the range of future outcomes?

b. What outcome do I think will occur?

c. What is the probability I’m right?

d. What does the consensus think?

e. How does my expectation differ from consensus?

7. Contrarian thinking can be beneficial at market extremes. To effectively act contrary to the masses one must know what the herd is doing, why it is doing it, why they are wrong and what your solution is.

8. Active investing and contrary thinking carry with it the risk of being wrong in hopes of reaping the reward of being right. An active investor seeks better returns than the herd at risk of falling ehind.

9. Howard Marks says it best, “Unconventional behavior is the only road to superior investment results, but it isn’t for everyone. In addition to superior skill, successful investing requires the ability to look wrong for a while and survive some mistakes.”

The CIG investment committee takes great pride in “Think Different”. We are currently over or underweight sectors, asset classes and markets in an attempt to limit risk while seeking to provide a return to meet our clients’ goals in their financial plans. The following are just a few items that we have a different opinion on than the conventional wisdom of many investors, a group that we call “the herd”.

1. The U.S. equity markets are still historically very overvalued—the herd is “buying the dip”.[xxvi]

2. Markets likely have not priced in an extended Russia/Ukraine conflict or the possibility of a China/Taiwan conflict, even though Blackrock rates the likelihood of both “high”.[xxvii]

3. The Fed raising rates at the fastest pace since 1981 and possible quantitative tightening as we head into a recession will be quite damaging to the economy and stock markets—the herd is already placing bets on the timing of the first interest rate cut.[xxviii]

4. Inflation will remain elevated for longer than most economists forecast—The herd believes inflation has peaked and will rapidly come down and the Fed will stop raising interest rates in the near term.[xxix]

Thinking differently is what allowed us to position our portfolios defensively in 2021 and as a result, year-to-date through July 31, our CIG Dynamic Growth Strategy composite has avoided approximately 54% of the growth benchmark’s losses and our CIG Dynamic Balanced Strategy composite has avoided approximately 61% of the balanced benchmark’s losses.[xxx]

Thinking differently does not mean being universally bearish or bullish about the future. Our thinking differently at CIG is about embedding imagination, like Steve Jobs did at Apple, in repeatable processes. In our case, we assess a wide range of scenarios and possible outcomes which are dependent on the path of critical, potentially life-transformative events to help clients succeed, regardless of how interesting the times are—now or at any point in the future.

We would welcome the opportunity to connect with you via voice or email to discuss how you think (differently) about life… about the markets and the value of active investment management.