Bob’s Journal for 5/25/23

Bankruptcies Are Accumulating

A few bankruptcies of big-name firms drew media attention in recent weeks.

But the big names are only part of the growing number of bankruptcies. Indeed, bankruptcies were expected to increase after the Federal Reserve’s rapid tightening of the money supply began about a year ago.

Once money becomes tight and interest rates rise, businesses that already had problems have even more problems. Many try to put off the day of reckoning in various ways, hoping the Fed will reverse its policies or that part of the business will surge.

But often those moves simply delay the inevitable. That’s why it takes months for the effects of tighter monetary policy to be reflected in the bankruptcy data.

Bankruptcy filings in the first quarter of 2023 were the highest since early in the pandemic.

In two days in mid-May, seven large Chapter 11 bankruptcy reorganizations were filed, including Bed Bath & Beyond, Envision Healthcare and Vice Media.

In May, we’re likely to see more bankruptcies of corporations with liabilities of $10 million or more than in any other month so far in 2023, according to the bankruptcy newsletter Petition.

There are many reasons we haven’t seen the end of the surge in bankruptcies. Revenues are declining or growing more slowly at many firms. Some sectors had sales surges during the pandemic that were unsustainable. Other businesses see their customers cutting spending because of rising prices or for other reasons.

Costs are climbing at many businesses, including employee compensation, supplies and materials, and interest on debt.

There also is less capital available to many businesses that have cash flow problems. Banks are cutting back their lending because of concerns about the economy and their own lower capital levels. Investors also are being more careful about making loans and equity investments because of concerns about the economy.

Fewer businesses are able to go public or sell themselves to larger companies. It is going to be a bad year for companies that have too much debt, or declining cash flow. S&P Global estimates that the debt default rate in the United States will increase to 4.25% at the beginning of 2024 from the current 2.5% rate, and will rise to 6.5% if there’s a serious recession.

These are good reasons to limit your positions in high-yield bonds, bank loans and preferred securities.

Stock Investors, Look Outside the United States

Most U.S.-based investors think primarily of U.S. stocks when they consider stock investments. That home-country bias cost them so far in 2023 and is likely to cost them more over the next few years.

U.S. stocks dominated investment returns the last couple of decades, and U.S. growth stocks delivered far higher returns than other investments.

But markets tend to “revert to the mean,” and the forces that provided advantages to U.S. stocks in general and U.S. growth stocks in particular are fading. Investors looking for high stock returns should consider markets outside the United States.

Consider the Japanese stock market. The major stock indexes in Japan peaked in the late 1980s and have been in a bear market since. Every time it appeared Japan’s economy and stock markets were set to recover, the rallies fizzled.

Until lately, that is.

The Nikkei 225 stock index is up more than 18% this year and recently hit a 33-year high, though it still hasn’t returned to the highs of the late 1980s.

While Japan has its economic problems, several factors make it an attractive investment. The stocks sell at good values relative to many other markets, especially U.S. markets. Japan’s long-term deflation and economic depression finally appear to have turned the corner.

The Bank of Japan shows little inclination to tighten its monetary policy and, in fact, seems content to keep interest rates low and let the yen decline against many other currencies.

Japan’s economy seems to be in better shape than Europe’s, and the United States appears to be more at risk of an economic downturn than Japan.

Another plus for investors is that officials of Japan’s government and stock exchange are encouraging companies to improve returns to shareholders.

Good ways to invest in Japanese equities include the ETFs iShares Japan Value (EWJV), Franklin FTSE Japan (FLJP) and Franklin FTSE Japan Hedged (FLJH).

Can IRAs Own Annuities?

Annuities are setting sales records, largely thanks to higher interest rates and lower stock prices. It has been years since annuities were able to offer yields comparable to today’s, and the annuities protect your principal.

Since many people have significant portions of their retirement savings in IRAs or 401(k)s, they frequently ask whether their IRA or other qualified retirement account may own annuities.

The answer is “yes.” IRAs, both traditional and Roth versions, are allowed to own annuities. So are other retirement plans.

IRAs can’t own life insurance, and that causes some people to mistakenly think IRAs can’t own any insurance products, including annuities.

Some financial advisors say that while annuities are permissible for IRAs, they aren’t a good idea. But I think that depends on the reason you’re buying an annuity.

Annuities provide tax-deferred compounding of income. If tax deferral is the main goal, there’s no reason to own an annuity through a traditional IRA. The annuity already offers tax deferral. (A Roth IRA makes the income tax free, an even better deal than tax deferral.)

But if you’re buying an annuity primarily for the guaranteed, safe yield and protection of your principal, there is no reason not to own it through an IRA.

Or if you want the guaranteed lifetime income provided through a single premium immediate annuity or a deferred income annuity, you can own that annuity through either an IRA or a taxable account.

There’s even a special type of annuity created exclusively for IRAs: the qualified longevity annuity contract (QLAC).

The tax code allows you to own annuities in your IRAs. Whether you should buy an annuity through the IRA or a taxable account depends on the details of your situation and your goals. But the option is available and should be considered when making your plans.

The Data

Sales of existing homes declined by 3.4% in April after falling 2.6% in March. Sales are down 23.2% over 12 months. The 12-month number has been negative for 20 consecutive months.

The median sale price of an existing home in April was $388,800. That’s 1.7% lower than 12 months earlier and 6.0% lower than the June 2022 peak.

Sales of new homes increased 4.1% in April. But new home sales for March were revised much lower to a 4% increase from the 9.6% increase initially reported.

April’s number of new home sales was the highest since March 2022.

The median sale price of a new home in April was $420,800, down from $458,200 12 months earlier. The average sale price was $501,000, which compares to $562,400 12 months earlier.

The Philadelphia Fed Manufacturing Index was negative 10.4 in May, but that’s a big improvement from negative 31.3 in April. The negative number indicates manufacturing activity declined in the Philadelphia area, but the decline in May was at the lowest pace in four months.

The Richmond Fed Manufacturing Index fell to negative 15 in May from negative 10 in April. The May level is the lowest in three months. Businesses continued to be pessimistic about business conditions.

The economy improved in the first half of May, according to the PMI flash indexes.

The PMI Services Flash Index increased to 55.1 from 53.6 in April. The PMI Manufacturing Flash Index declined to 48.5 in May from 50.2 in April.

The PMI Composite Flash Index improved to 54.5 from 53.5 in April.

New unemployment claims declined by 22,000 to 264,000 in the latest week. It turns out the previous week’s claims, which were an 18-month high, were inflated by a higher number of fraudulent claims filed in Massachusetts.

Continuing claims, which lag a week behind new claims, decreased to 1.799 million from 1.807 million.

The Markets

The S&P 500 rose 0.94% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.30%. The Russell 2000 jumped 2.98%. The All-Country World Index (excluding U.S. stocks) lost 0.65%. Emerging market equities fell 0.74%.

Long-term treasuries lost 1.80% for the week. Investment-grade bonds declined 0.38%. Treasury Inflation-Protected Securities (TIPS) decreased 0.50%. High-yield bonds gained 0.35%.

In the currency arena, the U.S. dollar gained 1.00%.

Energy-based commodities increased 1.05%. Broader-based commodities fell 0.50%. Gold declined 0.80%.

Bob’s News & Updates

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