Dear Friends,
As the second quarter’s earnings season kicks off, strong results combined with economic data led to the recession narrative losing some support, though the likelihood is still high by historical standards. These updates have been the focus of headlines recently and you may not have noticed that there are upcoming changes for 403(b), 457, and 401(k) plans that will reduce the amount of money high-income earners can deduct each year and may increase their tax bill. The details can be found in this week’s newsletter!
High-Earning Retirement Savers Are Losing Some of Their 403(b) Tax Break
Millions of high-earning Americans are slated to lose a popular tax deduction starting next year. Savers age 50 and older can make catch-up contributions in their 403(b), 457, or 401(k) accounts each year, with eligible workers allowed to put an extra $7,500 into their accounts, for a total of $30,000, this year. Starting next year, those catch-up funds will be funneled only into after-tax Roth accounts for those who earned more than $145,000 the previous year. The change is part of a set of new rules Congress passed in December. In 2022, 16% of eligible participants took advantage of catchups, according to Vanguard Group.
This change means many workers will pay taxes on their catch-up money upfront during high-earning years, rather than in retirement when they may be in a lower tax bracket. It stands to reshape how many Americans save for retirement and create financial and estate-planning strategies. Making catch-up contributions with pretax money has been a boon for high earners. For example, someone in the 35% bracket would receive a $2,625 tax deduction for a $7,500 catch-up contribution, while someone in the 22% bracket would deduct $1,650. While some Americans will pay more in taxes under the new rules, financial advisers say there will be a benefit to getting near-retirees to put more money into a Roth, where money grows and can be withdrawn tax-free. The changes don’t apply to IRAs, which allow a catch-up contribution in 2023 of $1,000 for savers 50 and over on top of the $6,500 annual limit.
Retirees with nest eggs in traditional accounts must pay ordinary income tax when they withdraw the money. In Roth accounts, workers can build a pot of tax-free money to spend in years in which tapping other accounts would push them into a higher tax bracket or force them to pay higher Medicare premiums. Many assume they will be in a lower tax bracket in retirement, but that isn’t always the case, said Ed Slott, an adviser who specializes in retirement accounts. Because high earners often amass large balances in traditional 401(k)s and individual retirement accounts, many find themselves in the same or a higher tax bracket when the Internal Revenue Service requires them to start pulling money out of those accounts at age 73.
Though the change is set to kick in on Jan. 1, 2024, some companies and plan providers say they need more time to meet the logistical challenges of identifying who earned more than $145,000 the previous year and retooling payroll and other systems to ensure their catch-ups go into a Roth. More than 200 employers, 401(k) record-keepers, and payroll providers recently sent a letter to Congress requesting a two-year delay
Economy, Geopolitics, and Commodities
1. Economists Are Cutting Back Their Recession Expectations
Economists are dialing back recession risks. Easing inflation, a still-strong labor market, and economic resilience led business and academic economists polled by The Wall Street Journal to lower the probability of a recession in the next 12 months to 54% from 61% in the prior two surveys.
While that probability is still high by historical comparison, it represents the largest month-over-month percentage-point drop since August 2020, as the economy was recovering from a short but sharp recession induced by the Covid-19 pandemic. It reflects the fact that the economy has kept growing even as the Federal Reserve has raised interest rates and inflation declined.
In the latest WSJ survey, economists expected gross domestic product to have grown at a 1.5% annual rate in the second quarter, a sharp uptick from 0.2% in the previous survey. They still expect GDP to eventually contract, but later, and by less. They expect the economy to grow 0.6% in the third quarter, in contrast to the 0.3% contraction expected in the prior survey, followed by a 0.1% contraction in the fourth. Nearly 60% of economists said their main reason for optimism about the economic outlook is their expectation that inflation will continue to slow. The Labor Department’s consumer-price index climbed 3% in June from a year earlier, sharply lower than the peak of 9.1% in June 2022 and the slowest in more than two years. The Fed’s preferred inflation measure—the annual change in the personal consumption expenditures price index excluding food and energy—has fallen from 5.4% in March 2022 to 4.6% in May. Economists expect it to reach 3.7% by the fourth quarter of this year, though that is still well above the Fed’s 2% target.
2. Home Sales Fall as Would-Be Buyers Face High Rates
Sales of previously owned homes fell in June as higher mortgage rates and a shortage of available properties frustrated buyers. Elevated mortgage rates are making home purchases less affordable, keeping many buyers out of the market and reducing demand. At the same time, the higher rates are discouraging homeowners from selling, limiting the supply of homes for sale.
The drop in both demand and supply means that the number of home sales has declined, but prices haven’t fallen much. In many parts of the country, buyers who can afford to stay in the market are still facing bidding wars. Existing home sales, which make up most of the housing market, decreased 3.3% in June from the prior month to a seasonally adjusted annual rate of 4.16 million, the National Association of Realtors said Thursday. That was the slowest sales pace since January. June sales fell 18.9% from a year earlier. Though prices are down slightly from last year’s peaks, they are still high on a historical basis. The national median existing-home price fell 0.9% in June from a year earlier to $410,200, the second-highest level on record in data going back to 1999.
The Federal Reserve’s actions to curb inflation by raising interest rates have most directly affected many consumers through their effect on the housing market. The Fed kept rates unchanged in June, and Fed officials have indicated they could raise rates again at their meeting next week. The housing market conditions vary significantly around the country. Home prices have fallen the most in the western half of the U.S., while prices continue to rise from a year earlier in many eastern markets. Economists surveyed by The Wall Street Journal ahead of the release had estimated that sales of previously owned homes fell 2.3% in June from the prior month. The average rate for a 30-year fixed mortgage was 6.96% in the week ended July 13, the highest level since November, according to Freddie Mac. The majority of homeowners have mortgage rates well below that level, and many are reluctant to trade in their current house for a different home with a higher rate, even if they would otherwise prefer to move.
3. What End of Ukraine Grain Export Deal Means for the World
Russia’s decision to quit the pact that allowed for the safe passage of crops by sea out of the country it invaded, Ukraine, has again stoked worries about global food supplies and access. The accord had helped temper prices of wheat and vegetable oil that skyrocketed last year when Russia’s attack cut Ukrainian ports on the Black Sea off from international commodity markets. Ukrainian crops will still make it to market via other routes, but the higher transport costs could depress the next crop plantings due in just a few months — curtailing global supplies longer-term.
Ukraine is Europe’s second-largest country by area, and its vast plains of dark, rich soil are ideal for farming. Food from Ukraine has helped to shape the course of European history, feeding the populations of fast-growing industrial cities in the 19th century, and sustaining the Soviet Union through decades of isolation. Before the war, Ukraine exported more grain than the entire European Union and supplied about half of the globally traded sunflower seeds and oil. Even in the 2022-23 season — the first full year under Russia’s invasion — Ukraine has held as the sixth-largest wheat shipper and third for corn. As the season came to a close at the end of June, Ukraine’s grain exports were more than 48 million tons, about steady with the 2021-22 season.
China, Spain, and Turkey have been the biggest buyers of Ukrainian foodstuffs shipped through the safe corridor, but poorer countries like Egypt and Bangladesh also imported over a million tons each under the program. The UN has emphasized that shipments under the deal help boost global supplies and bring down prices, regardless of where the grain is shipped. Global grain prices initially spiked after Russia’s exit from the deal. Ukraine is pushing for grain exports to continue from the Black Sea ports, despite Russian warnings. The US said shipping escorts are not an option, and insurance broker Marsh suspended its program for grain exports from Ukraine, underscoring the challenges. In the long run, if Ukraine can only export through alternative routes, that will increase costs for farmers. That could induce them to cut plantings further, resulting in lower supplies from Ukraine further out. The war has already cut the area that farmers are planting.
4. China’s Economy Barely Grows as Recovery Fades
China’s economy barely grew in the second quarter from the first quarter and youth unemployment hit a record high in June, providing evidence of a fading recovery that risks leaving the global economy underpowered this year as recession stalks the U.S. and Europe. The sluggish pace of growth in 2023 is piling pressure on Beijing to reignite an expansion that is in danger of fizzling out as consumers refrain from spending and exports slump. A drawn-out real estate crunch and shaky local-government finances are compounding the gloom.
China’s economy grew just 0.8% in the second quarter compared with the first three months of the year, and more than a fifth of Chinese aged 16 to 24 are out of work. The struggle to keep growth motoring ahead is the most pressing challenge among a lengthy list of issues facing Chinese leader Xi Jinping and his top officials. A difficult relationship with the U.S.-led West is squeezing investment in China. Beijing is sparring with Washington over semiconductors and the materials needed to make them. Russia, an ally, is sunk in a quagmire of its own making in Ukraine. Growth in the second quarter was less than half the 2.2% quarterly pace recorded in the January-to-March period. The result reflected weak retail sales, subdued private-sector investment, and a reversal in exports, which had propelled growth throughout the pandemic but are suffering now as major central banks ratchet up interest rates.
On an annual basis, economic growth accelerated, helped by a favorable comparison with 2022, when growth collapsed because of sporadic lockdowns under a government policy aimed at eliminating even the tiniest Covid-19 outbreaks. That weakness in 2022 means the economy is still expected to meet or even exceed officials’ goal of expanding by around 5% this year. But the loss of momentum after an initial burst of activity at the beginning of the year means China will need to do more to revive household and business confidence and get the economy back on track, economists say.
5. Macroeconomic Headwinds Dampen Metals Price Outlook
Last week, S&P Global Commodity Insights discussed consensus price forecasts for industrial and precious metals, including platinum group metals, amid broader market trends. Industrial metals prices rallied in June on expectations for further stimulus support for China’s stalling economic recovery, with measures seeking to boost consumer demand in the property and manufacturing sectors. Consequently, the September quarter consensus price forecasts are mostly above prevailing market price levels. The release of more disappointing economic data in China, however, has latterly tempered some of the optimism around the government’s policy effectiveness to sufficiently boost its economy. Alongside the prospect of further interest rate hikes in the US and Europe, the ensuing global economic uncertainty has triggered downward revisions to consensus price estimates for industrial metals in full-year 2023, but upgrades for gold and silver.
Industrial metals prices rose in the first half of June, supported by a pause to US interest rate hikes and a consequently weakening dollar, as well as demand recovery in China — buoyed by further stimulus support for its economy. Gold prices dropped to a three-month low in June, following the US Federal Reserve’s hawkish pause to interest rates hikes as US inflation moderated to 4% in May. Robust US jobs data, however, provided fresh impetus for Fed Chairman Jerome Powell to signal that there will be no let-up in the battle to curb inflation, fueling expectations for further rate hikes in the second half, the first of which could be as early as July. However, gold’s safe-haven investment status helped lift demand and prices at month-end. Bolstered by the uncertain economic and geopolitical backdrop, the consensus price forecast for gold has been revised to 0.7% higher in 2023 to $1,911 per ounce.
6. Brain Implants Allow Paralyzed Man to Walk Using His Thoughts
Gert-Jan Oskam was living in China in 2011 when he was in a motorcycle accident that left him paralyzed from the hips down. Now, with a combination of devices, scientists have given him control over his lower body again. Researchers in Switzerland described implants that provided a “digital bridge” between Mr. Oskam’s brain and his spinal cord, bypassing injured sections. The discovery allowed Mr. Oskam, 40, to stand, walk and ascend a steep ramp with only the assistance of a walker. More than a year after the implant was inserted, he has retained these abilities and has shown signs of neurological recovery, walking with crutches even when the implant was switched off. Jocelyne Bloch, a neuroscientist at the University of Lausanne who placed the implant in Mr. Oskam, added, “It was quite science fiction in the beginning for me, but it became true today.”
In the new study, the brain-spine interface, as the researchers called it, took advantage of an artificial intelligence thought decoder to read Mr. Oskam’s intentions — detectable as electrical signals in his brain — and match them to muscle movements. The etiology of natural movement, from thought to intention to action, was preserved. The only addition, as Dr. Courtine described it, was the digital bridge spanning the injured parts of the spine.
To achieve this result, the researchers first implanted electrodes in Mr. Oskam’s skull and spine. The team then used a machine-learning program to observe which parts of the brain lit up as he tried to move different parts of his body. This thought decoder was able to match the activity of certain electrodes with particular intentions: One configuration lit up whenever Mr. Oskam tried to move his ankles, another when he tried to move his hips. Then the researchers used another algorithm to connect the brain implant to the spinal implant, which was set to send electrical signals to different parts of his body, sparking movement. The algorithm was able to account for slight variations in the direction and speed of each muscle contraction and relaxation. And, because the signals between the brain and spine were sent every 300 milliseconds, Mr. Oskam could quickly adjust his strategy based on what was working and what wasn’t. Within the first treatment session, he could twist his hip muscles.
Financial Markets
1. Stock Market Today: Dow Edges Higher, Books 10th Straight Daily Gain
Major stock indexes finished Friday with mixed results, with markets stabilizing after yesterday’s selloff in the Nasdaq Composite. The Dow and S&P 500 logged weekly gains. Investors on Friday parsed U.S. economic data and news on Chinese stimulus as earnings reports trickled in. American Express, oilfield giant Schlumberger and advertising company Interpublic Group reported earnings.
As of Friday’s close:
The 30-stock Dow climbed 2.51 points, or 0.01%, to close at 35,227.69. The S&P 500 added 0.03% to end at 4,536.34, while the Nasdaq Composite fell 0.22% to finish the session at 14,032.81. The Dow narrowly notched its tenth straight day of gains, a feat not seen for the index since August 2017. On a weekly basis, the S&P 500 added 0.69%, while the Dow gained 2.08%. It was the second positive week in a row for the two indexes. The Nasdaq fell 0.57% for the period.
American Express Shares slipped about 4% after the company reported second-quarter revenue of $15.05 billion, falling short of the $15.48 billion expected from analysts polled by Refinitiv. However, American Express’ earnings per share beat expectations.
Capital One Financial rose about 1% after the financial company topped earnings expectations for the second quarter. Capital One reported adjusted earnings of $3.52 per share, which topped a Refinitiv estimate of $3.23 per share. However, its revenue missed expectations. Total deposits also decreased 2% at the end of the second quarter.
AutoNation tumbled 12.3% during midday trading. The car dealer reported second-quarter results that exceeded expectations on the top and bottom lines. AutoNation posted adjusted earnings of $6.29 per share on revenue of $6.89 billion. Analysts expected per-share earnings of $5.91 on revenue of $6.78 billion.
2. S&P 500 2023 Second Quarter Earnings Updates
At this very early stage, the second quarter earnings season for the S&P 500 is off to a strong start. Both the number of positive earnings surprises and the magnitude of these earnings surprises are above their 10-year averages. As a result, the index is reporting higher earnings for the second quarter today relative to the end of last week. However, the index is still reporting its largest year-over-year decline in earnings since Q2 2020.
As of July 14th,6% of the companies in the S&P 500 have reported actual results for Q2 2023 to date. Of these companies, 80% have reported actual EPS above estimates, which is above the 5-year average of 77% and above the 10-year average of 73%. In aggregate, companies are reporting earnings that are 8.8% above estimates, which is above the 5-year average of 8.4% and above the 10-year average of 6.4%.
The index is reporting higher earnings for the second quarter today relative to the end of last week, but slightly lower earnings relative to the end of the quarter. The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) earnings decline for the second quarter is -7.1% today, compared to earnings decline of -7.4% last week and earnings decline of -7.0% at the end of the second quarter (June 30). Positive earnings surprises reported by companies in the financial sector have been the largest contributor to the decrease in the overall earnings decline for the index over the past week. If -7.1% is the actual decline for the quarter, it will mark the largest earnings decline reported by the index since Q2 2020 (-31.6%). It will also mark the third straight quarter in which the index has reported a decrease in earnings. Seven of the eleven sectors are reporting (or are expected to report) year-over-year earnings growth, led by the Consumer Discretionary and Communication Services sectors. On the other hand, four sectors are reporting (or are expected to report) a year-over-year decline in earnings, led by the Energy and Materials sectors.
3. TSMC Delays Start of First Arizona Chip Factory
The world’s top contract chip maker, Taiwan Semiconductor Manufacturing Co., said sales are likely to decline 10% this year and a planned Arizona factory would miss its target of starting mass production next year. TSMC’s revenue and profit troubles disclosed Thursday reflected industry challenges including soft consumer demand, rising costs, and a shortage of various types of skilled workers. The company said people with expertise in erecting semiconductor facilities were in short supply in the U.S.
But it offered a more bullish midterm forecast, saying it expects big benefits from the blossoming artificial intelligence business, which relies on advanced chips often made by TSMC. The company said it expects revenue in 2023 to be down 10%, a larger percentage drop than the low-to-mid single digits it forecast three months ago. Revenue in 2022 was about $76 billion. It also reported that profit in the April-June quarter fell 23% compared with the same period a year earlier to the equivalent of just under $5.9 billion, the first such quarterly profit fall in four years. TSMC is pushing to finish its first factory in Arizona, a project supported by the Biden administration as part of its plan to make the U.S. a top chip-manufacturing hub again. Against the backdrop of worsening relations with China, Washington has been trying to build a chip supply chain centered around the U.S. and allies such as South Korea and Japan.
TSMC makes the main processors inside Apple’s iPhones. It has about 60% of the third-party chip-manufacturing business, followed by Samsung Electronics of South Korea at 12%, according to research firm Trend Force. The company said demand for AI-enabling chips is outpacing its ability to supply them. It said it is working as quickly as it can to build its capabilities in advanced-chip packaging, in which chips are stacked like Lego blocks to make more-powerful products. TSM shares dropped around 5% this Thursday.
4. Netflix’s Show Doesn’t Always Go On
Netflix had an interesting problem heading into its latest quarterly results—investors assumed everything was going right. The streaming giant’s share price has surged about 48% in the last three months. That was a notable run for a Hollywood titan in light of the dual labor strikes that have effectively shut down the entire industry’s output. Disney, Warner Bros Discovery and Paramount have seen their stock prices sink an average of 16% in that time as the growing acrimony between talent and management raises serious questions about the pipeline of movies and TV shows coming later this year and next.
Netflix was thought to be somewhat insulated from the strikes’ impact since it produces much of its programming in foreign markets not covered by the same labor unions. But the company indicated Wednesday that this might not be the case, which was both bad and good news. As part of its second-quarter report, Netflix boosted its free-cash-flow projection for the full year to $5 billion from $3.5 billion previously, citing lower projected cash content spending due to the strikes. But that effectively pulls forward free cash flow from next year, as Netflix said the move “may create some lumpiness.” It will need to resume spending on production once the strikes are settled. Wall Street had been anticipating $5.6 billion in free cash flow for 2024.
Still, all those new eyeballs aren’t fully paying off yet. Revenue of $8.2 billion during the quarter fell about 1% shy of the company’s own projection made three months ago. That suggests more new subscribers are opting into the company’s cheaper plans, including the recently launched ad-supported one. Hence, average revenue per paying subscriber was down 5% from the same period last year, and Netflix noted Wednesday that “current ad revenue isn’t material” in its shareholder letter. Netflix shares dropped nearly 9% in after-hours trading following Wednesday’s report.
Sources:
(1) www.bloomberg.com
(2) www.factset.com
(3) www.wsj.com
(4) www.nytimes.com
(5) www.barrons.com
(6) www.cnbc.com
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Economic forecasts set forth may not develop as predicted.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Investing in stock includes numerous specific risks, including the fluctuation of dividends, loss of principal, and potential illiquidity of the investment in a falling market.
Investing in foreign and emerging market securities involves special additional risks. These risks include but are not limited to currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.
Investment advice offered through Private Advisor Group, a registered investment advisor and separate entity from The Legacy Foundation.
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