April 27, 2024 | GDP, Personal Consumption Expenditures (PCE), S&P 500, Technology & S&P 500, Nasdaq and Do you Hold too Much Cash?

Smart Investing with Brent & Chase Wilsey

GDP

First quarter GDP was a large disappointment as it grew at an annualized pace of 1.6%, substantially below the estimate of 2.4%. I will say, considering there is a lot of data to collect the first reading can be subject to major revisions. As a recent example, in 2023 Q1 GDP had an initial reading which showed an increase of 1.1%, but it was later revised to 2.2%. It is possible we could see a similar situation with this report. Given the current numbers, there were still some positives. Although it was below the estimate of 3% and down from the Q4 reading of 3.3%, consumer spending in the quarter still grew nicely with a gain of 2.4%. There was quite a large discrepancy between goods and services spending as goods actually fell 0.4% and services climbed 4%, which marked the best quarter since Q3 2021. Goods spending was largely dragged down by a 1.2% decline in durable goods. Private investment was also very strong in the quarter as it grew 3.2%, residential investment was a large contributor to that number as it increased 13.9%. Government spending was also positive in the quarter with a gain of 1.2%. With all these positives, you might be wondering how GDP missed expectations. Areas that were negative weights on the report included the change in private inventories, which subtracted 0.35% from the headline number and net exports of goods and services, which subtracted 0.86% from the headline number. Private inventories can be a volatile metric that will depend on businesses restocking inventory. I would not be surprised to see this number turn positive in Q2 considering Q4 of 2023 was also negative and subtracted 0.47% from the headline number. This followed a nice benefit of 1.27% in Q3 of 2023. If consumer spending remains strong, businesses will likely need to restock inventory which should be a benefit moving forward. As for the trade imbalance, this came as exports grew 0.9% in the quarter, but imports rose 7.2%. Overall, I wouldn’t say this report was super strong, but I’m also not worried about the current standing of the economy as I am still anticipating a slowdown over a major recession.

Personal Consumption Expenditures (PCE)

The release of the March core personal consumption expenditures price index (PCE) was I’d say lackluster. It wasn’t as positive as I was hoping for, but I still don’t think it was that bad. The core PCE of 2.8% came in slightly hotter than the estimate of 2.7%, but it matched February’s number. Including food and energy, PCE increased 2.7%, which was also slightly higher than the estimate of 2.6%. Services continues to elevate prices as they were up 4% on a 12-month basis versus goods which increased just 0.1%. Overall, it is somewhat disappointing to see the deceleration in inflation slow, but numbers don’t always follow a straight-line trajectory. It will be interesting to see this report over the next couple months, but as of now the estimate for three rate cuts is looking a little more questionable.

S&P 500

The S&P 500 remains expensive based on several valuation metrics, but that doesn't mean you can't find buys out there. Although the index trades around 20x forward earnings, about 20% of companies are bringing up that multiple as they trade at double the index's valuation. The positive is there is about 20% of the index that trades at half the index's multiple. Much of the dislocation comes from the excitement over growth stocks and the index now has more than two times the allocation towards growth (46%) over value (21%). Historically the allocation has been more balanced and on average over the last 30 years the split has been an allocation of about 31% for growth and 32% for value. I continue to believe that numbers like these will be a reason for value's outperformance going forward.

Technology & S&P 500

I have talked many times about my concern with the over-concentration of the S&P 500 index in technology. The sector controls about 30% of the entire index, but what is crazy is Amazon, Tesla, Meta, and Alphabet are actually classified as consumer and communication stocks which would then understate the tech weighting of the S&P 500 (If you count Tesla as a tech company). If these were included, the weighting would be over 40%. The last time the index was so concentrated in tech occurred before the dot-com bubble burst in 2000. If you’ve held the Magnificent Seven over the last couple years, congrats, but for those that enjoyed the movie, you may remember four of the seven end up dead. Could we see a similar fate with these stocks?

Nasdaq

If you didn't do as well as the market in 2023, don't beat yourself up. The top 10 stocks greatly carried both the S&P 500 and the Nasdaq. In fact the average return for the top 10 stocks was 85.6% versus 16% for the other 490 companies. This meant that these top 10 stocks accounted for 63% of the index's return for the year. Over the past 30 years, the top 10 stocks have on average represented 24% of the index's growth. I do continue to worry many of these top 10 stocks could be a drag on the index and people's portfolios considering their lofty valuations.

Financial Planning:

Do you Hold too Much Cash?

Everyone needs some level of cash, and that number varies from person to person. For those with higher levels of assets, it can be possible to have too much cash which would be better off invested. We’ve seen people with $100k, $250k, $500k, or even over $1 million in cash which is likely way too much, even if it’s in a high-yield account or CD. Over time, cash will not perform as well as invested dollars. Right now, there are places where cash can earn over 5%, but this is still lower than market returns of 8% to 10% or more. Also, those 5% yields will be coming down as interest rates decline. We know there’s people out there who wait to time the market and invest their cash right at the bottom, but that generally doesn’t work out. From a tax perspective, cash produces interest which is taxed at a higher rate than investment income like dividends or capital gains. When interest is taxed at 10% or 12%, investment income would be taxed at 0%, and when interest is taxed at 22%, 24%, or 32%, investment income would be taxed at 15%. Not only is cash taxed at a higher rate, but its entire return is reportable as income every year, there’s no appreciation with cash. For example, if you have $500,000 of cash earning 5% for a total of $25,000, that entire $25,000 is reportable as interest income that year. If instead that $500,000 was invested in equities earning on average 8% made up of 2% dividends and 6% appreciation, you would only need to report the 2% dividend income of $10,000 as long as nothing is sold. This flexibility keeps your tax bill down but also reduces the chance of triggering AGI related issues like the net investment income tax or additional Medicare premiums. If you’re in the 4th tax bracket with an 8% investment return of $40,000, you’re only paying $1,500 in federal taxes from the dividends, plus $930 in state taxes if you’re in California. Comparing that with your 5% cash return of $25,000, you’d pay $6,000 in ordinary income taxes, $2,325 in state taxes, plus potentially an extra $570 net investment income tax, and/or another $3,000 in extra Medicare premiums. Now that 5% yield becomes 2.6% after tax while the invested dollars return 7.5% after tax. Investing can be volatile in the short-term, but over time it is a much better option than hoarding cash.

Stocks discussed: Nordstrom (JWN), Netflix (NFLX), Goldman Sachs (GS), and Palentir (PLTR)