by Franklin J. Parker, CFA
The Summary
- Payrolls for January posted last week. It was, on the surface, a good jobs report with 467,000 jobs added in January—considerably higher than most analysts expected. However, a change to how seasonal adjustments are applied did give a boost to the figure than we may have otherwise seen. Markets, in response to the strong figures, have begun to price five rate hikes from the Fed, which is more than the Fed itself sees for 2022.
- Interest rates have begun to bump up against some key levels. The 10-year treasury yield is now hovering around 1.9% and all of the expected cracks have begun to appear amongst high-flying tech names (and the new listings that are reliant on cheap capital). Inflation figures for January post on Thursday. 7.3% appears to be the expectation, which is still stubbornly high. With inflation in the crosshairs of the Fed, this print could easily push markets around.
- Rhetoric and actions surrounding the Russia-Ukraine standoff are adding to uncertainty. The US has sent troops to reinforce the area around Ukraine (though not in Ukraine itself), and talk of intense sanctions on Russia have grown. In last week’s report, I discussed the challenges of sanctions for investors so I won’t repeat them here. Suffice it to say, economic pain can be inflicted in both directions and investors should be prepared.
- Earnings season continue, and the news is generally good. Earnings growth has slowed a bit, and there is a big bifurcation: companies that are reporting profits seem to be reporting strong profits while poor reports seem to be very bad. Most notably, Meta, the parent company of Facebook, was severely punished after their lackluster earnings report—logging the largest 1-day loss in value of any company ever. This is, of course, adding to volatility in markets, as investors weigh earnings against the actions of the Fed. As I have said before, I expect this drawdown to be short-lived (though I do not yet believe we are at the bottom) and a good opportunity to deploy cash.
The Details
One of the first papers that was published on goals-based investing (though it wasn’t called that at the time) was on the effects of taxes in a portfolio.* The authors demonstrated that active trading strategies, even if they deliver better risk-adjusted returns, are often not good enough to overcome the tax drag they can create. In other words, it may look good on a statement, but not so good when the tax man cometh.
Seems strange to say now, but that one should account for taxes in an investment strategy was a new concept in 1993! In any event, it is just as relevant today as then, and our current market environment is a reminder of this.
I have, for months, talked about the likelihood of a selloff in the face of changing Federal Reserve priorities. Exactly how portfolios were prepared for this selloff, however, had as much to do with each client’s tax situation and financial goals as it did my view of the selloff itself. For short-lived selloffs, it is often not profitable to sell highly-appreciated positions to reset at slightly lower prices. The taxes on those sales often erodes the benefits of active management, no matter how accurate that active management may be.
There are moments, of course, when it is worth the tax cost.
The point is simply this: taxes are a critical factor in your investment strategy. They must be accounted for. Taxes are also highly individualized, so it can easy to disregard these variables in a general strategy. That is, in my view, a mistake. Keep an eye on tax costs.
*Jeffrey, R., and R.D. Arnott (1993) “Is Your Alpha Big Enough to Cover Its Taxes?” Journal of Portfolio Management, DOI: https://doi.org/10.3905/jpm.1993.710867.
Chart of the Week
This week we check-in on corporate earnings. As a whole, the S&P 500 has had 77% of reported companies beat expectations, with an average surprise of 4%. Of the companies that have reported, tech has had the most companies beat expectations (communications have only had 5 earnings reports, so I discount their 100% above expectations figure).
In sum, this is turning out to be a pretty good earnings quarter for US companies. Outlooks have shifted, however, with some sectors seeing considerably more downward revisions than upward (materials, for example). Even still, as a whole, the S&P 500 is seeing more upward revisions in expected earnings than downward.
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