2022 Summer Newsletter – Second Quarter Review

The current market turmoil highlights a fundamental truth about investing: it is not always easy. The S&P 500 entered bear market territory during 2Q, hitting the negative 20% mark for the year. This is despite overall company earnings growing in Q1. Goldman Sachs analysts estimate that higher earnings contributed a positive ~5.7% return to equity values, which was offset by a negative ~26% return from a contraction in P/E multiple – or the amount investors are willing to pay for a company’s earnings. This is largely the result of higher interest rates, which is also visible in the fact that the sectors with higher durations (i.e., more of their revenues and earnings are in farther out years) experienced the worst performance (Technology was down ~27%). The market continues to be worried by a hawkish Fed that is focused on raising rates to fight inflation and fears of the economic downturn that this might bring.

There is no doubt about the challenge the Fed faces as it seeks to engineer a substantial reduction in inflation without causing the economy to sputter. However, all recessions are not created equal. A recession is defined as a two-quarter decline in real GDP – that is GDP adjusted for inflation.  It has been nearly 40 years since we have experienced inflation at current levels, and higher inflation means it is by definition more difficult for the economy to grow on a real (net of inflation) basis. In today’s environment, this means nominal GDP growth (before adjusting for inflation) must be over 8%! What was considered strong nominal GDP growth of 4-5% (in a less than 2% inflation environment) is now no longer sufficient.

That said, a recession where nominal GDP growth is still relatively robust may mean unemployment rates that rise but remain relatively low and a consumer balance sheet that remains intact. This would constitute a very different experience than what happened back in the depths of 2008, or during the COVID recession. Of course, nothing is for certain and a lot depends on not only how quickly the Fed removes liquidity from the system but also what happens in the geopolitical landscape with Russia/Ukraine and China tariffs, which also have an impact on inflation through the global supply chain.

Given today’s uncertain environment, the following quote from Warren Buffett comes to mind: “It’s only when the tide goes out that you find out who’s been swimming naked.” This underscores our approach towards managing risk, particularly in periods of ample liquidity when risk aversion is low. Remaining prudent and not chasing after returns during ‘bubbles’ allows us to be better positioned to take advantage of opportunities that arise in periods like the present when asset prices decline and investors flee fearing that the tide will never come in again. We understand that the markets are driven by cycles,

and as long-term stewards of your capital, are always focused on buying good businesses at the appropriate valuations without worrying about what might happen in the short run.

Another item that we want to raise attention to is that Congress is considering a second round of modifications affecting retirement accounts, with particular attention towards Required Minimum Distributions, or RMDs. The Bill, HR 2954, is referred to as the Secure Act 2.0, a shortened version of the bill’s full name for “Securing a Strong Retirement Act of 2022” passed with overwhelming support in March, 414-5. Next up, we wait for the Senate to put forth their legislative proposal, which is currently in the works. The Senate Finance Committee approved more than 70 provisions on June 14, which will now be drafted into legislative form. Once a Senate bill passes, the House and Senate will need to reconcile the two bills, which in turn will firmly set the new legal standards. It seems almost assured that these changes are coming this year. While nothing is set in stone yet, here is what we expect the legislation to contain:

  1. 401ks funds are more readily available for emergencies.
  2. Increasing access to the saver’s tax credit. The Bill provides a tax credit of up to $1,000 for single filers and $2,000 for joint filers for those with modest incomes. 
  3. For active employees, companies will automatically enroll employees in their 401ks or 403b programs.
  4. Part-time employees will become eligible to participate in company retirement plans earlier.
  5. Student Loan payments can trigger contributions from the employer into the employee’s 401k/403b. This might function as a retirement plan contribution ‘match’ for loan repayment dollars, up to a given threshold.
  6. Catch-up contributions are currently available for those over age 50, allowing for another $6,000 per year to be contributed. Under Secure Act 2.0, the catch-provision would expand to $10,000 for those ages 62, 63, and 64. Both the Senate and House proposals require these catch-up contributions to be made as Roth contributions.
  7. Most Importantly, the RMD age will be pushed out to a later age, likely to be age 75. The House plan increases the RMD age to 75, but over a series of steps, not arriving to age 75 until the year 2033. Similarly, the Senate proposal gets to age 75 by the year 2032.
  8. Currently, contributions to Roth 401k/403b are given matches (assuming the plan has a match provision) with tax-deferred dollars. The Secure Act 2.0 would allow for matches to be made on Roth contributions with Roth contributions by the employer. 

The only immediate action is specifically for those having their 72 birthdays in 2022. Under current law, you need to take an RMD on your retirement accounts this year. Assuming you do not need the cash, we advise waiting to see what develops with the Secure Act 2.0 before initiating any RMD withdrawal. This may allow for a lower tax liability this year. Also, for those executing Roth conversions annually before we need to take RMDs, we may well end up with more years to be able to convert in before RMDs kick in.

Lastly, we are sorry to say goodbye to our advisor Trent Blossom. We enjoyed the short period of time that he was part of the Cribstone team. With a new baby on the way, Trent has taken a new role that will allow him to live closer to family. We wish him the best in his future endeavors.

Scott Upham, CIMA® CPWA®
Managing Partner

Contributions were made to this letter by Amyn Moolji, CIO and COO, & Jeffrey Burch, Director of Wealth Management.

Cribstone Capital Management (“CCM”) is an SEC-registered investment advisor located in the State of Maine.  The firm and its representatives are in compliance with the current registration and notice filing requirements imposed upon SEC-registered investment advisors.  CCM may only transact business in those states in which it is notice filed or qualifies for an exemption from notice filing requirements.  For information pertaining to the registration status of the firm, please contact the SEC on its website at www.adviserinfo.sec.gov.  A copy of the firm’s current written disclosure brochure discussing the firm’s business operation and fees is available from CCM upon request.

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