Bob’s Journal for 6/20

The Stock Indexes Became More Top Heavy

Last week was another strong one for the S&P 500 Index, adding to a generally strong year. But few stocks are doing as well as the index, and the disparity between winners and losers widened last week.

The S&P 500 returned 1.58% for the week ending June 14. But only 183 stocks in the index had positive returns for the week, according to Bespoke Investment Group, and a mere 99 stocks beat the index.

A review of the index sectors shows a similar disparity.

The technology sector surged ahead of the index, gaining 6.42%. But it was the only sector that beat the index, and real estate was the only other sector with a return exceeding 1%, earning 1.19%.

Two other sectors had positive returns, communications services (0.88%) and consumer discretionary (0.27%).

The other seven sectors had negative returns, with financials and energy each dropping 2% or more.

The S&P 500 also is divided into 24 industry groups, and they show the same disparity.

Three industry groups beat the S&P 500 for the week, and all are part of the tech sector. Only seven industry groups had positive returns. Nine industry groups had losses of 1% or more.

For more evidence of the divergence of returns in the stock markets, look at last week’s returns of the different indexes in “The Data” section below.

This divergence has continued for some time. That’s why the gap between the returns of capitalization-weighted indexes and equal-weighted indexes is historically large.

In the past, significant performance gaps closed after a while. Eventually, investors decide the prices they’re paying for the top-performing stocks are too high and that earnings won’t keep pace with the valuations.

In anticipation of such a turn, I’ve been recommending that investors have positions in Invesco S&P 500 Equal Weight (RSP) and the small company ETF iShares Russell 2000 (IWM).

Supreme Court Decision Revises Estate Tax Valuations of Many Small Businesses

The recent Supreme Court decision in Connelly v. United States upended estate planning for many small business owners.

The facts in the case were simple and commonplace.

Michael and Thomas Connelly were sole shareholders of a corporation that operated a small building supply business.

They had an agreement that after one of them died the other would have the option to purchase the deceased brother’s shares. If the surviving brother declined, the corporation would be required to buy the shares, leaving the other brother with 100% ownership.

To ensure it would be able to buy the shares, the corporation took out $3.5 million in life insurance on each brother.

After Michael died, Thomas declined to purchase the shares. The corporation purchased them after obtaining a valuation that they were worth $3 million.

The federal estate tax return listed the value of the shares Michael held at his death as $3 million.

But the IRS disagreed. It said the life insurance proceeds had to be added to the value of the business. That made the value of Michael’s shares more than $5 million, according to the IRS, and resulted in additional estate taxes of about $890,000.

The estate argued that when valuing the corporation, the life insurance proceeds should be offset by the obligation to use them to purchase Michael’s shares. The insurance proceeds shouldn’t be included in the corporation’s value for estate tax purposes.

The U.S. Supreme Court agreed with the IRS and two lower courts. The contractual obligation to redeem the shares isn’t a liability for estate tax purposes. It doesn’t reduce the corporation’s estate tax valuation.

But the valuation does include the life insurance proceeds. The court said an independent buyer would buy Michael’s shares for an amount that included the value of the underlying business plus the life insurance proceeds.

Small business owners who have similar redemption agreements as part of their estate and small business continuation plans should reconsider the plans.

They might keep the plans but realize how the estate tax calculation has changed. Or the plans might be replaced by cross purchase agreements in which the shareholders own life insurance on each other’s lives and the surviving shareholder is required to buy the deceased shareholder’s stock.

Or a trust or LLC that’s independent of the operating business entity can be used to own the life insurance and buy the deceased shareholder’s stock.

Even if your estate won’t be valuable enough to trigger estate taxes, the case is likely to affect the estate plan.

For example, the Connelly decision changes the basis of the stock for the estate, and the sale of the stock to the surviving shareholder could result in a capital loss to the estate.

The result depends on the terms of the stock redemption agreement. The executor also might be obligated by fiduciary duties to seek a higher price for the shares.

Every business with more than one owner needs to meet with their estate planner to review the effects of the case and whether to revise their plans.

New Key Questions to Ask Before Buying a Condo

Many retirees downsize by selling single-family homes and purchasing condominiums. Others adopt a two-home lifestyle by purchasing a condo where they plan to spend part of the year, usually in a warmer climate than their principal residence.

Changes in the insurance market make these plans more difficult and financially dangerous.

In the typical condo, the individual condo owners own only the airspace and contents of their units. Through the owner’s association or some other entity, they own a share of the buildings, common areas, and grounds. (Details vary between states and individual projects.)

The owner’s association is responsible for insuring the buildings and other property it owns.

Insurance for condos is rising rapidly, according to The Wall Street Journal.

The paper reported on condo associations that in recent years were quoted premiums for the upcoming year that were several multiples of previous premiums. And coverage under the policies was reduced.

Some of the condo associations are raising monthly dues on members or dipping into reserves. Others are taking out lines of credit or imposing special assessments on the members to pay the premiums.

The biggest premium increases are in Florida and California, primarily the result of hurricanes and wildfires, respectively.

But, as with individual homeowner’s insurance, condo associations in other states are feeling the bite because inflation increases the cost of any loss. Also, insurers are spreading their costs around the country, increasing premiums in areas not affected by wildfires or hurricanes to help cover those losses.

Keep in mind that in some areas residential buildings that look like single-family homes are structured as condos.

If you’re considering buying a condo, take a deep dive into the insurance situation for both the individual unit and the condo association. Learn about past dues increases and review minutes of recent association meetings for tip-offs to potential insurance premium and dues increases as well as special assessments.

The Data

The Consumer Sentiment Index from the University of Michigan declined to 65.6 through mid-June from 69.1 at the end of May. That’s the lowest level since November 2023.

Consumers became more concerned about inflation and reported a significant decline in their assessments of current economic conditions.

Home builders were less optimistic in June, the second straight month the Housing Market Index from the National Association of Home Builders (NAHB) declined. The index was 43 in June, 45 in May and 51 in April.

Retail sales increased 0.1% in May, following a 0.2% decline in April. Over 12 months, retail sales increased 2.3% through May and 2.7% through April.

Excluding autos and gasoline, retail sales increased 0.1% in May after declining 0.3% in April.

Industrial production jumped 0.9% in May after being unchanged in April. Over 12 months, industrial production advanced 0.4% through May and declined 0.7% through April.

Manufacturing production rose 0.9% in May following a 0.4% decline in April. Manufacturing production increased 0.1% over the 12 months through May after being down 0.9% for the 12 months ending in April.

The Producer Price Index (PPI) declined 0.2% in May after rising 0.5% in April.

About 60% of May’s decline was the result of a 7.1% fall in gasoline prices.

Over 12 months, the PPI increased 2.2% through May and 2.3% through April.

The core PPI, which excludes food and gasoline, was unchanged in May and up 0.5% in April.

Over 12 months, the core PPI rose 2.3% through May and 2.4% through April.

The Empire State Manufacturing Index improved in June but still indicates the sector is contracting.

The index increased to negative 6.00 from negative 15.60 in May. The June level is the highest in four months. The last positive reading was in November 2023.

New unemployment claims increased by 13,000 to 242,000 in the latest week. That’s the highest level since August 2023.

Continuing claims, which lag a week behind new claims, increased to 1.820 million from 1.790 million. That’s the highest level in almost five months.

The Markets

The S&P 500 rose 2.15% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.37%. The Russell 2000 increased 0.05%. The All-Country World Index (excluding U.S. stocks) lost 0.80%. Emerging market equities advanced 1.44%.

Long-term treasuries gained 2.24% for the week. Investment-grade bonds increased 0.55%. Treasury Inflation-Protected Securities (TIPS) added 0.78%. High-yield bonds fell 0.03%.

On the currency front, the U.S. dollar advanced 0.56%.

Energy-based commodities increased 1.36%. Broader-based commodities dropped 0.12%. Gold rose 0.34%.

Bob’s News & Updates

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