January 2024 Letter

Dear Valued Clients & Friends,

As we close the chapter on 2023 and start 2024, I want to take a moment to reflect on the journey we've navigated together and look forward to the path that lies ahead.  This past year has, once again, taught us the invaluable lesson that the world of investing is as unpredictable as ever and timing the market is a difficult endeavor.  Most of 2023’s returns were in November and December with the S&P 500 up over 13% in those two months alone.  2023 was a testament to the power of patience and resilience. We've witnessed periods of volatility and uncertainty, yet through it all, long-term thinking has yielded a year of growth where the losses of 2022 have mostly recovered.

I had this same image below in my letter from last January, but the image is worth sharing again.

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2022 was a historically awful year.  2023 is not shown yet in this chart, but it would be in the top right quadrant for positive stock and bond returns. Illustrated another way, annual returns on investments over the last ten years are summarized below.

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This is the essence of successful investing; not reacting impulsively to short-term market movements and going to cash, but, rather, staying focused on our long-term objectives: long-term gains.

In our company’s view, the greatest risk in investing is not market volatility, but our own reactions to inevitable volatility. This year, more than ever, has proven that point. By maintaining a disciplined approach and not swaying with the winds of market speculation, we have navigated this year's challenges with a focus on the future.  As we move into 2024, our strategy remains consistent. We will continue to focus on a diversified portfolio tailored to your individual goals and risk tolerance. If you are in retirement or close to retirement, we will hold the right amount of cash and short-term bonds to fund a few years of needed portfolio distributions.  Our commitment to this disciplined, long-term approach is unwavering because we know that time in the market is more critical than timing the market.

Despite a long-term economic optimism (addressed in my November 2023 letter), short and medium-term headwinds are in play. With that, short and medium-term opportunities exist as well.  I will summarize a few of those items in this letter.

Did the Federal Reserve Pivot?

There has been significant buzz around the Federal Reserve’s December meeting and, potentially, the long-awaited "pivot." What is this “pivot?”  In financial terms, a “pivot” by the Fed refers to a significant change in its monetary policy direction. In layman’s terms and in the current landscape, this means a pivot away from high interest rates. For the past year and a half, the Fed's primary focus has been on fighting inflation, where they have raised interest rates in an effort to fight said inflation.  In the December meeting, the Fed backed away from future rate hikes, and now the average Fed forecast sees three rate cuts in 2024.  This is akin to a driver making a sharp turn on the road.

One of the big effects of a Fed pivot is the loosening of financial conditions, which leads to lower bond yields and higher stock prices.  This loosening can make the Fed’s inflation fight more difficult and left many surprised when reviewing the Fed’s December rhetoric.  In my eyes, even though the Fed held interest rates at 5.25-5.50%, the Fed has set the pivot in motion with Jerome Powell, Fed Chair, saying “we believe that our policy rate is likely at or near its peak for this tightening cycle.”

With these facts, it is pretty clear within the Fed’s own projections that the pivot is here with forecasted rates falling to 3% by 2026.

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The next Fed meeting will be January 30, 2024, and we will know more definitively then if the pivot has truly commenced.  As I have mentioned in previous writing, I think they must pivot.

Higher interest rates put more stress on fiscal policy and the government budget (We are already seeing the highest deficits since World War II because of interest on the national debt). $17 trillion of U.S. debt matures in the next three years that has an average interest rate well below today’s rates (some debt is at half a percent). If that debt were refinanced at today’s rates of 4-5%, the interest expense would more than double.  The Fed must pivot and cut rates as their boss (the U.S. Government) would have a fiscal crisis if rates stay where they are.  We consider the pivot fast-approaching, if not already arrived.

The Commercial Real Estate Conundrum

In our ongoing tracking of the U.S. Economy, one area of concern since the pandemic is the commercial real estate sector, particularly urban office buildings. This sector shows signs of distress, which could potentially trigger the next economic downturn. A recent episode of 60 Minutes offers an in-depth look at this issue. I highly recommend watching it for a more comprehensive understanding of the situation. It is a short piece that addresses the issue in a digestible way.

https://www.youtube.com/watch?v=TfUhykd1Ifc&t=9s

Key takeaways:

• Office tenants have been making active space decisions with the new work-from-home world of today, leading to potential 40% reduction in the value of office buildings.
• The weakness in office spaces is unprecedented, and banks need to come to grips with the potential losses this poses.
• $1.5 trillion in commercial real estate loans are set to expire in the next two years, raising concerns about the future of some cities and the commercial real estate sector.
• The reimagining of office space should be far more ambitious, combining public and private money and ideas for what to do with old, unusable office space.

At Foundation, we do not typically invest in commercial real estate except for an occasional, small REIT (Real Estate Investment Trust).  Nevertheless, it’s an important area many do invest in and worth keeping an eye on.

The Bitcoin ETF

As you may know, a number of spot Bitcoin exchange-traded funds (ETFs) were recently listed, with trading already underway. I had quite a few clients ask me about the ETF in the last few weeks because it has been so prevalent in the financial news.  Given my own interest in this asset class, I thought it would be beneficial to provide you with a clear understanding of what it all means.

Let's start by clarifying a few essential terms:

• Exchange-Traded Fund (ETF): Think of an ETF as a basket of investments, like stocks or bonds, managed by a fund provider. When you invest in an ETF, you own a share of this basket, not the individual assets. The value of your share goes up or down based on the collective performance of these assets, which is tracked on an index. ETFs are traded just like stocks on regular exchanges.
• Cryptocurrency: This is a digital asset, existing on a blockchain – a kind of digital ledger that's transparent and unchangeable. Cryptocurrencies are also known for their limited supply which contribute to their value.
• Bitcoin: The most recognized cryptocurrency, Bitcoin, has a significant market capitalization, reaching nearly $1 trillion. In 2023 alone, its value surged by approximately 154%.

The Backstory, SEC's Perspective, & Looking Ahead

The SEC's approval is crucial for any ETF to be listed and traded. Bitcoin enthusiasts have been attempting to launch a Bitcoin ETF since 2013, but it was not until January 10, 2024 that the SEC approved the registration statements for eleven spot Bitcoin ETFs. This followed a court ruling in August 2023 that criticized the SEC's earlier rejections, especially given their approval of Bitcoin-tracking futures funds.

The anticipation of SEC approval led to mainstream financial players, including BlackRock and Fidelity, filing for Bitcoin ETFs. These ETFs offer a more straightforward way to invest in Bitcoin, bypassing the complexities of direct purchasing. Significantly, Bitcoin ETFs are much easier to include in IRAs, brokerage accounts, and employer-sponsored 401(k) plans, making them more accessible to the average investor.  However, it's important to note that the SEC's approval of these ETFs doesn't equate to an endorsement of Bitcoin as an investment.

Please note that I am providing this information to keep you educated and informed; I am not recommending any specific action in this letter. As part of our ongoing commitment to offering you a diverse and robust investment portfolio, it’s important that I share information I find important.  The digital asset class is polarizing and volatile and may not be suitable for every investor.  As your trusted advisor, CPA and Certified Financial Planner, I believe in the value of transparency. To that point, I currently hold positions in Bitcoin ETF within my personal investment portfolio. This disclosure is made to address any potential conflicts of interest and assure you that my education and any recommendations are made with your best interests in mind.  Furthermore, my education to my clients is grounded in a thorough respect of my duty of care as a Certified Financial Planner. I am committed to acting in your best interest and considering any investments to enhance portfolio diversification and meet your specific investment objectives and risk tolerance.  I believe these assets could accomplish this for some.

As I said, I now own the Bitcoin ETF in my own portfolio.  I hold it because…

1. Diversification: Bitcoin, as a digital asset, may have a low correlation with traditional asset classes like stocks and bonds. This can help in diversifying a portfolio and potentially reducing overall risk. Diversification is a core principle of modern investment strategies for preserving capital, as it spreads exposure across different assets, which can stabilize returns in volatile markets.
2. High Return Potential: Bitcoin has shown the ability to deliver high returns compared to traditional investments. While past performance is not indicative of future results, Bitcoin's impressive growth trajectory, particularly over the past decade, showcases its potential as a high-reward investment.
3. Inflation Hedge: Bitcoin is often viewed as a hedge against inflation. Bitcoin’s supply is capped at 21 million tokens and provides a contrast to fiat currencies, which can be subject to devaluation through more monetary creation. This characteristic makes it appealing in scenarios where investors are concerned about the purchasing power of their currency.
4. Technological Innovation and Adoption: As a leading cryptocurrency, Bitcoin is at the forefront of blockchain technology, which is gaining increasing acceptance and integration in various sectors. Its growing acceptance by institutions and potential for wider adoption in the financial system could increase its value over time.

The inflation hedge argument is what has historically drawn me into the asset class.  There are numerous inflationary and deflationary forces in today’s world, and no one can know which will win out.  If there is deflation, your cash and bonds should reward you.  If there is continued inflation, I believe Bitcoin exposure could significantly soften the blow to cash and fixed income investments with Bitcoin’s appreciation in value.  This is why I include it in my own portfolio.

It is a fascinating emerging asset class that is worth knowing more about. If you have questions about the asset class or want to consider it for your portfolio, I am always available to you and would enjoy doing that analysis.  The high volatility and risk prevents me from most initial allocations or additional allocations without your buy-in and acceptance of the inherent risks.

The Positives from Here

I get a reputation with my loved ones and coworkers for being a bit enigmatic.  I see a lot to be positive about and a lot to be negative about!  Nothing has changed in the three months since drafting my November letter.  We have a lot to be positive on in terms of technology, innovation, and age demographics.  We have things to be negative on fiscally.  The fiscal negatives are solvable and respected Jeff Gundlach, CEO of DoubleLine Capital has opinions on how to fix part of the fiscal problem, addressed in my blog earlier this month; it just takes some tough decisions.  As one of my favorite people from history, Sir Winston Churchill once said “You can always count on the Americans to do the right thing, after they have exhausted all the other possibilities.” We are clearly in the process of exhausting the other possibilities.

Concluding Thoughts

Remember, the journey to financial security is a marathon, not a sprint. It's about making informed decisions, grounded not in the fear of the present but in the confidence of the future. As your financial advisor, I am here to guide you through these decisions, offering clarity and perspective when the path seems unclear.

Thank you for your continued trust and partnership. Here's to a prosperous and fulfilling 2024, where we continue to build on our progress, learn from our experiences, and move closer to achieving your financial goals.

Happy New Year, and here’s to a healthy and prosperous 2024!