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The Manley Macro Memo

Its Time to Consider a Roth Conversion

It is a great time to consider a Roth Conversion (converting your 401K or Traditional IRA into a Roth IRA) because tax rates are unlikely to be this low again. In December 2017, Congress passed the 2017 Tax Cuts and Jobs Act (TCJA), which reduced tax rates to today’s historically low level.

While these tax cuts are scheduled to expire in 2025, the massive budget deficit due to the Covid-19 pandemic, the unprecedented national debt burden, and the aging of the Baby Boomer generation may lead to higher taxes sooner – especially if the Democrats win the Georgia Senate run-off in January.

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Congress Fails as the Virus Accelerates, yet the S&P 500 Sells at a Record Valuation?

We believe that stocks offer a poor risk-reward. Despite the great uncertainty over the virus, the economy, and the election, stocks have never been more expensive because the Fed created another financial bubble by printing $3 trillion.

We believe the economy and the financial markets are vulnerable without additional stimulus to support the service economy until a vaccine is widely available.
Unfortunately, it is unlikely that Congress will agree to a new stimulus bill until after the election is decided.

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Did the Fed Induced Bubble Burst?

Despite the severe recession, 11.6 million jobs losses since February and little progress containing the virus, the S&P 500 reached an all-time high in August due to the Fed’s massive liquidity injection coupled with investors flight to the safety of the mega-cap technology stocks (Facebook, Apple, Amazon, Google, and Microsoft).

The Fed’s market intervention led to a speculative bubble concentrated in the mega-tech stocks, which has burst. The market is in a correction, which we expect will last until the election is decided.

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Is Your 60/40 Portfolio Safe?

We expect that the Fed will maintain 0% interest rates for the foreseeable future, and they will use QE to finance the Federal budget deficit. We expect that these policies will gradually monetize (or inflate away) the enormous debt burden, but will also lead to stagflation – rising prices (a loss of purchasing power) and sluggish economic growth.

This economic environment will be treacherous for investors who use a 60% stock, 40% bond asset allocation. The 60/40 traditional blend has worked great since 1981 because bonds were very profitable (falling from 15.8% to 0.50%), and lower interest rates led to higher stock market valuations. Also, since the Fed always cut interest rates during economic slowdowns or recessions, bonds acted as an essential equity hedge during bear markets.

Currently, the 10-year U.S. Treasury bond yields only 0.60%, so it will provide limited protection if the economy falters, and it will provide a negative real return (after inflation) each year for the next decade. During periods of stagflation, it is essential to reduce the portfolio’s bond exposure and invest in TIPS, gold, and commodities, which perform well during inflationary periods.

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The Fed Gave Investors a Gift it’s Time to Sell in May and Go Away

We are less than two months into the worst recession since the Great Depression. More than 30 million people have lost their job, and the duration of the virus and the recession are unknowable, yet stocks are priced for perfection.

The Coronavirus will accelerate the move away from globalization, as countries adjust their supply chains to become more self-reliant. Reorganizing supply chains will lead to short-term disruptions that could create more economic stress. Longer-term, declining globalism will lead to more domestic jobs, at the expense of high prices and lower profitability.

Valuations are at record highs, corporations have a record debt burden, and share buybacks will be limited

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The Manley Macro Memo