Price Reduced: What's on the Horizon in 2023?

As we close out the first quarter of 2023, market conditions seem poised for a recession. After a historically bad year in 2022, investors are feeling uncertain. Have we reached the bottom? Is recession inevitable?

In our most recent Thirdly presentation, Morgan Arford and Brian Lockett discussed economic current events and outlook based on data from similar conditions in past years. We also looked at the real estate market and recent changes to the SECURE Act.

Markets: Putting 2022 in context

In terms of market conditions, 2022 was highly unusual: Stocks and bonds were down together, which since 1926, has only happened about 2% of the time. The other 98% of the time they’ve either moved up together or opposite each other with bonds typically outperforming in falling markets.

What can we expect for 2023? Only time will tell, but key indicators are making a strong case for bonds and market-neutral assets – especially for those individuals who are in the preservation and distribution phase of their investment journey, where maintaining their current lifestyle is a top priority.

The main factors we look at to assess market environments are the strength of the economy overall, economic momentum, interest rates, investor behavior and valuation. The economy is showing a sharp slowdown and contraction, suggesting that a recession is on its way. This is deliberate, as the Fed has aggressively raised interest rates in an attempt to slow down the economy and combat inflation. The consequences of slowing the economy are GDP drag and lower corporate earnings, which are a net negative for market valuations that tend to fluctuate with those variables.

Investor behavior remains speculative and greedy, in contrast to polling data that measures sentiment as fearful and bearish. Many investors are speculating that stocks will rise again because we’ve been conditioned to assume the Fed will step in and make a correction when a market hiccup occurs. This time, in the event of a sell-off, the Fed won’t be able to act without risking a reignition of inflationary pressures. After 14 years of relying on the government to save the day, bullish investors may be in for a rude awakening.

Another factor to consider is the shape of the yield curve regarding lending. At the end of 2020, the ratio between short-term and long-term interest rates favored longer-term loans that carried a higher-yield at the time. Now in early 2023, that ratio has inverted, as short-term lending now yields a higher return. This inversion is a sign of economic dislocation that has been associated with recession every time it’s occurred since the 1970s – nearly the deepest inversion on record.

In short, the modest growth in January was not enough to assume the bear market is over. Looking at historical data, from 2000 to 2003, the market rallied more than 10% four distinct times before reaching its lowest point. The 2007 to 2009 recession saw three rallies before the market low.

Weathering the storm

In addition to tumultuous markets, we in the Seattle area have experienced real estate whiplash. As the Fed lowered – and then raised – interest rates to combat first the COVID-19 pandemic and then record inflation, the real estate market in our region experienced a frenzy followed by a lull. Low interest rates drove residents to invest in vacation homes and rental properties – which may now come on the market as shadow inventory as conditions tighten. Many residents who locked in mortgages at COVID-era interest rates are feeling tied to their homes and reluctant to take on a new mortgage as interest rates increase.

Ultimately, inflation is the fly in the ointment. We’ll see conditions continue to contract the longer inflation goes unchecked – one potential upside of the impending recession is that those economic environments are inherently deflationary. A decent contraction may just be the right tool to slay the inflation monster.

What’s new with the SECURE Act?

The Setting Every Community Up for Retirement Enhancement (SECURE) Act went into effect at the beginning of 2020, and it got an update this year as SECURE 2.0. Here are a handful of changes we’re excited about for our clients:

• RMD age. While SECURE 1.0 raised the age at which you must begin withdrawing required minimum distributions (RMDs) from your IRA from 70.5 to 72. SECURE 2.0 increases it to age 73. That’s good news for those who haven’t begun withdrawing RMDs yet and can delay another year.
• RMD penalties. The penalty for failing to withdraw an RMD has been reduced from 50% to 25%. But, the trade-off may be that the IRS is less forgiving than they have been in the past, and the penalty will be more strictly enforced.
• Non-spousal beneficiaries. Just like with Secure Act 1.0, if you inherit a retirement account from someone other than a spouse – for example, a parent – the window to withdraw those funds has been reduced from your lifetime to 10 years. However, with Secure Act 2.0, it’s not yet clear if those distributions must be taken equally over the 10 years, or if the amounts and timing with withdrawals can vary like before. We should have clearer guidance later this year.
• 401(k) catch-up contributions. In 2023, people age 50 and older can make catch-up contributions to their 401(k) accounts of up to $7,500. However, starting in 2024, the catch-up contribution is subject to an income limit of $145,000. If you make more than that, your catch-up contribution will be diverted into the Roth side of the plan. Also, starting in 2025, people age 60 to 63 will be able to contribute an additional $10,000 to their 401(k) plan, though the same $145,000 income limit will apply like in 2024.
• 401(k) employer match. While previous law dictated that the employer 401(k) match be contributed to the tax-deductible side of the plan, the new law allows employees to elect to have employer contributions go to the Roth side of the plan. As a result, the employee is taxed on that money in the year it’s contributed but never again.
• Simple and SEP Roth IRAs. Simple and SEP IRAs have historically been funded with pre-tax dollars. SECURE Act 2.0 allows for Simple and SEP Roth IRAs, enabling after-tax contributions to these accounts with tax-free growth just like in a Roth IRA or Roth 401k.
• 529 rollovers. Starting in 2024, those with 529 plans that meet certain conditions can begin rolling those funds into a Roth IRA tax-free, with a lifetime rollover limit of $35,000.

Looking ahead in 2023

With so many factors outside of our control, difficult times are when discipline matters most. One of our core tenets at CWM is to focus on what you can control, and not what you can’t. You’ve heard us say it – sometimes twice! – in every Thirdly presentation. Market conditions like the ones we’ve all recently experienced are where that mantra was born, and a careful and data-driven approach has served us well throughout CWM’s history. It’s easy to look at the headlines and think the sky is falling – and that’s why we work tirelessly to gather and analyze data to enable well-informed decisions. We continue to advise making mindful and careful investment decision, and not reacting out of fear.

If you have questions about your specific situation as we move further into 2023, don’t hesitate to give us a call at (425) 778-6160 or request a meeting here. We’re always happy to talk it through and give you the context you need.

*The market indexes discussed are unmanaged and generally considered representative of their respective markets. Individuals cannot directly invest in unmanaged indexes. Past performance does not guarantee future results. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost. No investment strategy can guarantee a profit or protect against loss.

**This material is not intended to replace the advice of a qualified tax advisor, attorney, and accountant or insurance advisor. Consulting with the appropriate professional should be done before any financial commitments regarding the issues related to the situation are made.