Skip to main content

Mercer Advisors Capital Markets Update and Outlook: October 2021

Mari Adam

CFP®, MBA, CRPC®, Sr. Wealth Advisor

Oct 28, 2021

Doug Fabian:   
Welcome, ladies and gentlemen. Looking forward to our webinar today. We’re going to get started in approximately two minutes. [Pause 00:00:14 – 00:01:18] Welcome, clients and friends of Mercer Advisors. This is our quarterly Markets Capital Markets Update and we’re looking forward to spending the hour with you. My name is Doug Fabian. I’m part of the Client Communications team here at Mercer Advisors. Great to have you with us on another discussion about what’s going on in the economy and the markets. Before we get into content, let me remind everyone who is watching this live that there is a questions tab in your, go to webinar toolbar.

This is where we would like you to submit questions. We’re going to dedicate about 40 minutes of our hour together to content and then we’re going to spend 20 minutes answering your questions. I think this is the part of the webinar where people really are able to connect with what’s going on in the markets, the economy, ask specific questions of our chief investment officer and one of our premier investment advisors and get some real-time connection. Joining me today is Don Calcagni, our Chief Investment Officer and Mari Adam. Mari is one of our Senior Wealth Managers and she’s going to be providing a great perspective as being one of those wealth managers who’s on the front lines each and every day with clients. One of the things that we want to do of course, is begin this discussion with a nice message from our attorneys. Obviously, we live in a highly regulated world.

We have made every effort to make sure that all the information that we present to you today is accurate and current but the most important part of this message is we don’t want you to act on any of the information you receive today. We’re not here to give personal investing advice. Certainly one, of the things that we want to do is encourage you to reach out to your Mercer Advisors advisor specifically, have those conversations discuss your portfolio and any changes that you want to make to your financial plans. Keep that in mind as we’re going through the course of today’s program. Let’s talk about our agenda today.

As always, we’re going to talk about what’s going on in the economy. We’re going to review the scoreboard. This is a scoreboard business. How are the markets doing so far this year? We’ll look at US markets, international markets. We will look at the fixed income world and give you some perspective on what’s going on. Our big topic of discussion today is inflation and then we’re going to get into some Q&A. With that preview, I wanted to go right to Mari Adam. Mari, you’re speaking with clients each and every day. You’re down in the southern part of the United States in Florida. Just give us some perspective on some of the conversations that you’re having lately with clients and what you’re hearing out there.

Mari Adam:     
Definitely. In the last several weeks, we’ve had quite a few conversations with clients as we talk about their portfolio and they looked at all the headlines. Doug and Don, you know what is in those headlines. It’s news about interest rates, it’s news about inflation, the debt ceiling, there’s no shortage. I think clients are feeling a certain amount of frustration that there’s 60 days or so till the end of the year and it’s very hard to prepare for January 2022 without some guidance from Washington. We are having some really valuable one-on-one conversations with clients and trying to help them make sense of their position and work out a list of next steps, things we can do before year-end.

Doug Fabian:   
Excellent. Well, Don, let me turn things over to you and we’ll jump right into the numbers and what’s going on in the economy.

Don Calcagni:   
Great. Well, thank you Doug, thank you, Mari, for joining us today and thank you to all of our listeners for giving us some of your precious time. We certainly hope that you find today valuable. I always like to begin our conversations by looking directly at real world economic data. My favorite economic data is what we call high frequency economic activity. These are things that I think really drive what I call the real economy. What I want to draw your attention to are these activities that you see in this greenish perforated box here that I just highlighted. Things like mortgage applications, hotel occupancy, credit card transactions, US seated diners, things like that. What I want to draw your attention to is the column that says current. What we’re really looking at here is we’re measuring this activity relative to where it was basically pre-COVID.

If you look at the column to the left of that where it says minimum, that was really the maximum decline in these different economic activities back when COVID first hit. If you look at US seated diners, it was down 100% because we shut down the entire economy. Businesses across diners, restaurants, places to eat, they were basically all shut down. If you look at the current column, what you’ll see is that it’s really a mixed bag. US seated diners, those activities are still down about 8% relative to where we were pre-COVID. TSA traveler traffic still down 23%. Unsurprisingly, things like debit and credit card transactions are up 20%. We’re all shopping on Amazon even more than we were pre-COVID. I think all of us have discovered DoorDash even those of us who didn’t know what DoorDash was prior to COVID.

What’s really happening right now in the economy in my view, is that the economy is in the process of rapidly evolving. It’s remaking itself. There’s a lot of things that are going to look very different post-COVID than what the world looked like pre-COVID but I think the economy is still trying to figure that out at the moment. So, still very much a mixed bag when we look at current high frequency economic activity. Now, when we look high level at the economy over the past year, we have seen a very powerful economic recovery which was coming on the heels of very poor economic performance. Obviously in 2020, when COVID hit, the economy cratered quite significantly.

Towards the end of last year, the economy began to reopen. We had multiple vaccines. We got past the election. The economy really reopened with a force and a vigor that candidly, it has not seen since the end of the 2nd World War. So, a very powerful economic growth. For the majority of 2021, what’s not on this particular screen at the moment is the fact that economic activity right now is actually rapidly slowing down. At the moment, the Atlanta Fed estimates that the US GDP growth is only about a 0.5%. We’re going to talk a little bit about that here in a little while. We’re going to talk about inflation, supply chain disruptions but there’s definitely some friction on the wings of the US economy at the moment that we’re going to have to work through.

One of the biggest frictions, I would argue the biggest friction on the wings of the economy at the moment is inflation. Murray mentioned these headlines that are really on the minds of our clients at the moment. I would argue they’re on the minds of all US citizens at the moment and that is inflation. I want to draw your attention to the purple box in the upper right-hand corner of your screen, specifically that number that says Headline CPI. That stands for Consumer Price Index. I like using the Headline CPI because that’s that measures inflation across all goods and services. There’s other measures of inflation that tend to carve out things like Food and Energy. That’s what core CPI is but I like looking at everything.

I’m a data nerd so I want to see all the data. Inflation is running pretty hot. It’s running at around 5.2% over the prior 12 months. It is important to keep in mind that inflation is not a forward indicator. It’s not something that’s happening right now necessarily. It’s actually something that happened in past tense. It’s measuring a change in prices over the past month or over the past year. Over the past year, we’ve seen inflation of about 5.2%. That is a significant increase from where we were historically. If you look at the bottom right-hand corner of your screen, if we just look at the past several years and indeed, for the past I’ll say two decades, inflation has been quite anemic. In fact, over the past couple of decades, the US federal reserve has been more worried about deflation than inflation. That has obviously changed and today, inflation, I would argue, is the top concern on the minds of policymakers.

Doug Fabian:   
Don, I’d like to ask Mari. Inflation is different for everyone. It really depends on where you are in life in your life cycle. Mari, what kind of color can you add around that issue in conversations with clients, some being affected by inflation more than others?

Mari Adam:     
Well, I think a lot of our clients are very concerned about inflation. It’s something we haven’t seen in the United States at a serious number for quite a while but they’re very concerned about how it may erode the value of their portfolios and that’s certainly important. Inflation will have a major impact on investments, the type of investments you choose and your ability to preserve your purchasing power which with today’s longevity, is really a key issue. It is like Don says, it’s a major concern for many of our clients.

Doug Fabian:   
Great. Thank you. Don?

Don Calcagni:   
I would add to that, I think it’s an excellent point is that inflation is different things to different people and it really depends on the specific basket of goods and services that you purchase. For example, if we look at what was driving inflation earlier this year, was a big increase in the price of used vehicles. Well, if you weren’t in the market for a used vehicle, arguably, that inflation obviously did not impact you but it is important to talk to your advisor to understand how inflation will impact you personally. The other side of the inflation coin is really what I would just say are interest rates.

If we actually look at what’s been happening to interest rates over the past say a year or so, it’s really been really two different stories. Coming into 2021, we saw interest rates, specifically the 10-year US treasury yield really take off like a rocket until about April. Ironically, it was in April when we started to see some really high inflation data. Interest rates actually leveled off and then actually came down and they actually hit bottom in August of about 1.19% for the US, for the 10-year US treasury bonds. Now, since that time, since it bottomed at 1.19%, the difference is that the inflation data that we’ve been seeing has suggested that inflation is not going to be temporary.

If you recall, if you were paying attention to the headlines, the US federal reserve earlier in the year said, “Yes, we have inflation but it’s transitory. We think it’s going to be temporary.” Well, by the end of August or early September, there was some economic data suggesting that’s not true. This looks to be stickier and more persistent, more widespread than what we were originally led to believe. I’m not saying anyone was being untruthful. This is the nature of economics. The economy is infinitely complex. But new information came to light. The market had to reassess that. What we have seen since interest rates bottomed out in August is a pretty powerful resurgence in interest rates. At the end of September, the 10-year was around 1.52, 1.53 percent.

As of yesterday, it was around 1.66%. Interest rates continue to rise and I would argue that is happening in response to this increase in inflation that we’ve observed throughout the economy. Let’s pivot and start taking a look at markets. The general economic backdrop is we know there’s a lot of inflation. There’s a bit of a mixed bag in terms of GDP growth and what it’s going to look like going forward. Interest rates are rising. What about equity market returns? I want to draw your attention to the green box. I know there’s always lots of data on our slides but I want to draw your attention to the green box here because I think this is what’s important.

These are year-to-date equity market returns, stock market returns for the US, for the world outside of the US and different markets. You’ll see the emerging markets down there. You’ll see that the S&P, positive. 15.9% through the end of September. Non-US markets depending on which market we’re talking about, they’re up anywhere from 6.3 to 10.2 percent. The emerging markets which have been the laggard year-to-date are down about 1% overall. There’s probably a couple of points that I would like to just to highlight here is this is really the inflation hedge in your portfolio. It’s obviously not going to come from bonds. It’s not going to come from fixed-income typically just because those interest rates are still low.

Now, they’re getting higher and that’s a good thing for those of us who are reliant on that income. But as we’ll see in a moment here, rising rates also puts downward pressure on bonds, right. So, you’re going to see some losses in the bond market. I would just highlight that while the emerging markets are negative slightly overall, the emerging markets sleeves of our portfolios are actually positive, anywhere between 5 to as high as 12% at the moment depending on which particular portfolio you’re in. If you want to know exactly how you’re doing, of course, always reach out to your advisor there but an interesting anecdote. As markets rise, I think a natural concern is — well, gee, what about valuations? Isn’t the stock market getting really, really expensive? The short answer to that is yes.

As someone who’s charged with managing client wealth, I always obsess over valuations and so do your advisors. They constantly reach out to me trying to understand — how should we think about market valuations? If you actually look at this purple box here on the far right, you’ll see that currently the S&P 500 is trading at about 20.3 times next year’s earnings. That’s how we think about valuations typically, is in terms of cash flows or profits or earnings. What you’ll see is that that ratio has actually come down from its high earlier in the year. I’ve said this publicly and I’ve written this in several articles. that there’s two ways to deal with high valuations.

The bad way to deal with high valuations is for the stock market to come down in value, for prices to come down. The good way, the preferred way to deal with high valuations is through earnings growth. Thankfully this year, we have seen stellar earnings growth. Remember, I showed you a few moments ago that the economy had a very powerful, very vigorous recovery for most of this year. Well, with that, we saw an increase in corporate profits. They’ve grown almost 40% thus far this year and are forecast to continue to grow in 2022 by about 10% at the moment. That economic growth has found its way into earnings of companies and that has helped to bring down to some degree, the overall valuation of the US equity market. That’s the good way to deal with high valuations.

Doug Fabian:   
Don, if I could jump in here and have you comment. One of the things that we’re not getting into in detail today is the valuation levels of the international markets as well as the emerging markets. But I’d just like you to comment because most of our clients in diversified portfolios have exposure to those areas and we see some value there.

Don Calcagni:   
Absolutely. Valuations absolutely matter, they always matter. When we look outside to the non-US markets, Doug, what we observe is if we actually look at stocks in other countries, they on average trade at about a 30% discount to their US counterparts. If you’re concerned at all about valuations, which I would argue you should be, and if you’re concerned about growth, and I would argue you should be, you definitely want to have an allocation to non-US companies.

When we look at GDP growth over the next 5 years or 10 years, the majority of the economic growth on the planet will not occur in the United States. It will occur in the emerging markets especially. You definitely want to have an allocation to those markets in order to profit, to benefit not only from those low valuations but also from that economic growth that we’re going to see in those markets going forward.

Doug Fabian:   
I also want to take just a moment to remind all of you listening to the webinar live today, please submit your questions. I’m getting some great questions that we’re looking forward to answering here in just a little while but you can use the toolbar. Click on questions, type in what you’d like to ask us and we’re going to do our best to answer as many questions as we can today. Go ahead, Don.

Don Calcagni:
Let’s finish out our market review by now pivoting and taking a look at the bond market. Like I said a few moments ago, as rates rise, bond prices come down. If you look within this green box here in the center of your screen, we’re sharing with you year-to-date returns for different asset classes in the bond market. For example, if we just look at the 10-year treasury, that’s the US treasury bond backed by the full faith and credit of the US government is actually down 4.24% year-to-date. That has nothing to do with the credit worthiness of the US government. That has everything to do with changes in interest rates. Interest rates have risen. That has subsequently pushed down the current value of bonds trading in the market.

Similarly, we see that in the 30-year treasury, we see that in investment-grade corporate bonds, which are down 1.27. And then the US aggregate bond market, that’s basically the index for investment grade US bonds, negative about 1.55%. Now, if you look at these purple arrows to the left, the plus side here is that going forward now, the yields that we earn on our bond investments have gone up. If you’re looking at the US aggregates, it went up from 1.12% to 1.56%. If you actually look at that in actual hard dollar terms, that’s a pretty significant increase in income. For those clients who are reliant on that income, I would argue that’s a positive despite the fact that we have seen the value of those investments go down slightly thus far year-to-date.

This is probably a good time to pivot, Doug and Mari, to start talking about inflation. This is arguably the most, I would argue, the most dominant headline at the moment. I’ve actually communicated this to clients over the years. My personal view is that inflation is the most serious threat to our clients, to retirees’ financial security. Not market volatility, I would argue not even taxes, it’s inflation and making sure that we have a financial plan and a portfolio that’s positioned to outperform inflation over the duration of their retirement. Let’s take a look at Headline monthly CPI inflation.

If we look at the left-hand side of the screen for just a moment, this is the monthly inflation that we saw last year during 2020. If you go back to early last year, you’ll see we have these big declines. That’s deflation. Prices actually went down in March, April and were actually flat in May. It wasn’t until June that we started to see a little bit of a recovery in prices throughout the economy and we actually saw a little bit of deflation in November. I would argue that was due to the presidential election. A lot of anxiety, consumers were stepping back from spending. But once we got past that, we had a series of new vaccinations.

We got past the elections and the economy began to reopen quite vigorously. Coming into 2021, it is perhaps no surprise that we saw inflation take off like a rocket. You can see that. You can see that for the really for the first half of the year, inflation was running really, really hot. It has since started to taper a little bit on a monthly basis, July, August, September. It looks like it’s come down. It’s still running high by historical standards like I showed you earlier, it’s running at about 5.2% on an annualized basis at the moment. Again, that is a backward-looking number but at least on a monthly basis, it looks like it has tapered a little bit. Now, what this data does not include is recent increases in the price of oil energy.

Come November, we’ll get our October data for inflation and that will certainly include probably a pretty big increase in energy inflation. What’s driving inflation at the moment? It is oil, it’s energy, it’s gasoline, it’s kerosene. It’s all of these different things. In order to understand what’s happening in the energy market, I think we have to go back to 2020. If we go back to last year, what we’ll see if you look at this box in the bottom center of your screen, you’ll see that little blue line, that’s the number of active rigs, rigs that are drilling for oil. You’ll see that that fell off a cliff when COVID hit. That was because, just to refresh our memories, if we go back to April of last year, April of 2020, the futures contracts for oil were trading at a negative $37 a barrel, right.

The economy had contracted so dramatically that producers began to dramatically cut production. We see that here towards the top of the screen, that top purple box, you’ll see that global production last year was about 94 million barrels a day but we were only consuming about 92 million barrels. Anytime that production exceeds the demand, price is going to come down. We saw that quite dramatically last year when prices really, really collapsed. Now, if we pivot and we look at 2021 this year, what we observe is that, well, we were consuming more than we were producing. Demand exceeded supply. Prices have gone up quite dramatically.

I think it’s important to note that if we look at the bottom, the box in the bottom center of the screen, is that while the rig count has increased, it has not increased enough to equalize supply and demand in the oil markets. OPEC cut production by 12 million barrels a day back during 2020 and they have since then, not increased that production, all right. Again, we have a basic imbalance here between supply and demand. If we look to 2022, we’re forecasting that production will actually exceed demand. That should start to bring prices back down. I think that one of the biggest questions out there is — well, why does demand exceed supply? Why are producers not bringing more oil to the market? It really has to do with supply chain disruption.

All of these rigs, they require humans to operate them. Right now, the labor market is really tight. By the way, this is not unique to oil companies. This is throughout the entire economy. Some of my favorite restaurants here in my town are running on an abridged schedule because they just can’t find the people they need to operate. I think this is really has to do with supply chain disruption, has to do with the fact that the economy opened up quite vigorously this year. Many of us have been traveling domestically, fueling up our vehicles, going camping or doing a road trip. Demand has increased quite dramatically yet production has not been able to keep up with demand. Add to that the fact that we’ve had several serious hurricanes hit the Gulf Coast which has taken a number of rigs out of production.

Those rigs require basic materials, they require new parts. They require labor in order to get those rigs back online. Longer-term, we expect that this should start to equalize but at least in the short-term, until these supply chain disruptions get ironed out, we’re probably in store for a little bit more pain at the pump than we would otherwise appreciate. But going forward, we think that’ll probably levelize itself. Okay. Doug, this really brings us to the end here with our key takeaways. Mari, how about you walk us through these? I know a lot of these are advice and we were talking about this before today’s call but why don’t you take us through these and we’ll just we’ll go from there.

Mari Adam:     
That sounds great. The first one, this is a technique that we have been using with clients. Each year, more and more clients really look at this and think it’s a great way to handle some of their charitable giving to some of their favorite charities. Here’s a thought — you can make these gifts directly from your IRA in a very tax efficient manner. It’s called a QCD, Qualified Charitable Distribution. Unfortunately, you do have to be 70 and a half to do this but for people who have money, they’re taking out of their IRAs and they do have charities to support, it’s a very tax smart way to make those gifts. You can also do them, not through your IRA but to donor advised funds. It’s also a way to get money to charities, get a deduction very smoothly.

That’s something we would urge clients to look at before the end of the year if you’re charitably inclined. It’s relatively easy to do and you can talk to your advisor about that. The second thing that is a little timely, do think about Roth conversions. If you’re not familiar, a Roth conversion just means you’re taking money out of your IRA account. You’re paying tax on it and then you’re putting that money into a Roth IRA where it will never be taxed again. It’s a great tax move. These are good moves to make if for example, your income is lower this year. Maybe you didn’t work part of the year. We have a client with very large solar tax credits that’s going to implement a strategy of Roth conversions to use up those credits.

The other people that I think should take a good look at Roth conversions are those who may be retired. They’ve stopped working but they’re too young to take money out of their IRA. They may be too young to take Social Security. They’re in a very short period of time when their tax rate is lower. This is a good way to take advantage of today’s tax rates which frankly, are pretty low historically and they may go up in the future. You need to get these done before December 31 if you’re thinking of doing it. The third thing everyone knows that they have stock positions that may have appreciated. They’ve gone up during the year. That’s always good news but the bad news is sometimes, those positions get a little large and you really should be more proactive, to use Don’s favorite word, about taking some of those capital gains. Why — because capital gains are pretty low right now and they might not be this low in the future. So, it’s really a good idea to trim away at some of those concentrated positions. I don’t know if Don wants to put in a word or two about some of the different ways to do that?

Don Calcagni:   
Yeah, no, for sure. One way to do that, Mari, is through systematic rebalancing, right. Take the emotion out of the equation. We do this for our clients automatically. We certainly encourage you if you want to understand how we do it, if you want to learn more about what different rebalancing strategies we have, certainly reach out to your advisors but certainly systematic rebalancing is one way to do that. Just to highlight what we were just discussing a moment ago. I just walked everybody through the fact that equity markets are up quite handsomely year-to-date.

Well, I want to remind all of us that this year’s excellent equity market returns, first-off, they have significantly outperformed inflation. So, that’s the inflation hedge in your portfolio. But number two, those returns are coming on the heels of very powerful returns last year and the year before. If you have not rebalanced your portfolio for a number of years, chances are it’s quite lopsided and certainly due for some rebalancing. We certainly encourage you to have that conversation with your advisor and do that.

Mari Adam:
Right. The time to do it is now because if you look back last year to March 2020 when we had the market decline from COVID, you don’t want to wake up one morning and say, “Gee, I should have done it yesterday.” So, now, is the chance to get this done. Number four is a as a small thing you can do. We work with a lot of parents or grandparents who really want to help their kids. They may be young kids like high schoolers with their first job, they might be young professionals or they may be grandkids. But one of the great ways you can really get younger people in your family on the right path is if they have working income, they can open a Roth IRA. You can help them fund that Roth IRA if they don’t have the available cash to do it.

It’s a great way to help them learn about growing their money over time in a Roth IRA and making some of those investment decisions and getting them involved in investing. That’s something before the end of the year although you do have until next April 15 to fund your Roth IRAs. But do look if you have younger kids in the family, again, could be young adults, could be grandkids but it’s a great way to help them out if you have a little extra cash and you have the means to do that. And then our last point here is before the end of the year, make sure you are meeting with your advisor to really reassess your risk tolerance, your financial plan and as Don mentioned, rebalance the portfolio.

This is so important because you might have started out with a certain allocation and many of the portfolios at Mercer are automatically rebalanced. You don’t need to worry about this but for others, it is something that you do need to look at and go in and do. If your portfolio, your equity position has grown, first, congratulations, that’s wonderful news but it is really time to maybe trim back a little. Take some gains, tax rates we feel are quite low now compared to what they could be in the future, and also take some time to update your financial plan. We know there’s a lot of uncertainty right now because we don’t know the direction of legislative proposals but you have a great team here at Mercer. You have Don, his investment team, you have the estate planning team and they’re really standing by, keeping their eye on those changes that might come through so you can take action but make a move to talk to your advisor and update your plan before the end of the year.

Doug Fabian:   
Thank you, Mari. Again, ladies and gentlemen that was a great summary of really personal finance suggestions that we have for you. We would want you to be proactive with your personal wealth manager, having a conversation with your advisor about some of those things that might apply to you. Let’s shift and get into our Q&A. I got to say, we have a lot of great questions in the queue. Certainly, if you have a question in the audience and you’d like to get involved, please use that toolbar question tab to send us a message. Don, I’m going to go to you first. The there are several questions around China. I’m going to give you all three. What is in a general 100%-equity portfolio, what is our exposure to China? When we’ve heard this news of course, and the impact of a specific company, Evergrande, over in China, could there be more of those kind of things lurking out there? Give us your synopsis of what our exposure is and then talk a little bit about the Evergrande situation.

Don Calcagni:   
Thank you, Doug. Just speaking high level, our typical equity exposure to China, meaning the whole country, not Evergrande, I’ll speak to Evergrande in a minute, but our entire exposure to China as a market is currently around 1.3 to 1.4%. So, exceptionally small. Now, when we actually look within our China exposure, we have zero exposure to Evergrande. That was one of the first things we started tracking late in the summer knowing that Evergrande was having trouble repaying its debt, making its interest payments. We reached out to our managers, looked at the portfolios and thankfully, we had zero exposure to Evergrande in those portfolios. The other question around — gee, are there other problems lurking out there specifically within China?

First-off, it’s always really hard to tell. Trying to get accurate quality information out of China is exceptionally difficult but I would say that there’s probably problems elsewhere in the Chinese economy. The Chinese economy is heavily indebted and about 20% of China’s GDP growth is tied directly to real estate. I think it’s no surprise, many of us have heard this, I actually got to experience it firsthand about five years ago, if you go to China, I mean, there are entire ghost cities, just forests of buildings that are empty. To say that there’s probably a property bubble in China is probably a very accurate statement.

Now, the degree to which that could spill over into other markets, everyone I’m talking to, everything that we’re reading and researching, it tells us that that is probably very, very limited. That’s because the Chinese economy doesn’t have things like derivatives like we had back when Lehman Brothers went bankrupt. Most of the debt in China that’s issued in China by Chinese companies tends to be owned by Chinese banks, tends to be owned by mutual funds, by ETFs, things like that. It’s not a derivative which is really what helped really fuel the US financial crisis back in 2008, 2009. I think that’s where a lot of investors go, is they think — gee, could what happened to us back then happen in China today? I would never say never but it doesn’t seem likely when we at least look at the current state of development of Chinese financial markets. At the moment, it looks like that the problems associated with Evergrande, the problems associated with the Chinese economy are largely contained within China itself.

Doug Fabian:   
Mari, I want to go to you on this next question. To give you context, client is asking, considering Mercer Advisors’ investment approach, what’s the fiduciary viewpoint around ESG investing? I don’t know if this is coming up in client conversations. Don, I know you might want to contribute to this question as well but we’re really getting this client asking the question, really just our traditional approach versus ESG.

Mari Adam:     
Why don’t I take the client approach and Don can certainly speak to the investment end. Not every client but many clients and in fact, a growing number of clients are very interested in ESG. Some, because it meshes with their value system and they feel very strongly and I think other people, just because they realize ESG can be a component of doing good business and doing good for your company. Mercer does have options for us to use ESG. It is something we do try to raise with many of our clients. Definitely, there is a growing interest especially among women and especially among younger investors. It undoubtedly is growing.

Doug Fabian:   
Don, please address the issue of — hey, are you leaving money on the table going to ESG? What’s the comparison between a traditional approach and ESG, what’s the latest research?

Don Calcagni:   
Yeah. Mathematically, when we actually look at the data, Doug, you’re not leaving any cash on the table if you take an ESG approach. That’s because the ESG marketplace today is big enough to where you can still build an exceptionally well-diversified portfolio. If you actually look at the companies today that dominate financial markets, it’s not the coal-fired power plants and things like that. It’s your technology companies, right. Tesla just passed a trillion-dollar market cap. You can you can still build a very well-diversified portfolio and in fact, if we look at ESG returns over the past decade they’ve actually outperformed non-ESG type companies. Think of your big oil companies, think of your commodity producers, they all substantially underperformed companies with really high ESG ratings over the past decade.

Now, I like to look at all the data like I said earlier. When we actually go back to 1990 and look at about three decades worth of data, what we see is there’s really no statistically meaningful difference between the returns on an ESG versus an non-ESG portfolio. So, I would argue you’re not leaving anything on the table. To Mari’s point and this speaks to really our investment capabilities when you look at our investment platform, is that it is critically important that clients build portfolios that align with their values. It’s your money after all so it makes perfect sense that if you want certain types of companies included or excluded from your portfolio, the great thing is we can do that for no additional charge and actually, custom tailor that portfolio to ensure that it’s well-aligned with client value systems.

Now, we do have portfolios that I would say are for lack of a better term, non-ESG portfolios. That doesn’t mean that they’re blind to all of these issues. For example, if you even look at our non-ESG portfolios, they actually score very high in different ESG metrics. For example, we pay very close attention to the governance scores of the different managers that we work with. We want to make sure that the funds are being well-managed. We want to make sure that the fund manager is voting the proxies for the underlying companies. It’s not to say that our non-ESG portfolios are completely blind to it but they are, I would say, a little bit more diversified. They’re going to own those energy companies perhaps that you would not find in a traditional ESG portfolio. Doug.

Doug Fabian:   
I lost my view there for a second. Can you hear me, Don?

Don Calcagni:   
I can.

Mari Adam:     
Yeah.

Doug Fabian:   
Okay, good. Let me jump to the next question here. Mari, this is to you. We have a client just asking, in your earnings years versus your retirement years, what’s really the difference in inflation? What are the concerns, what are the areas and how would you be coaching clients on, you know?

Mari Adam:     
I would quite, rather than looking at inflation per se, to me, what would be most meaningful is looking at what’s the appropriate investment allocation. Of course, everyone is different so there’s no right answer but it’s really important to focus on growth whether you’re young or even a retired investor at age 60 because the total game changer in our world today is longevity. In the old days, you would retire at 65 and you would die. Now, it’s we have to plan for 30 years, almost 40 years. I think the best example is William Shatner who just went into space at age 90. I mean, what an example. Longevity really is a game changer for us, very important.

Whether you’re young or still thinking about retirement, I would be less concerned about inflation but more getting the growth you need over the years because many of the households we work with are going to live into their 90s, 95 and even 100. You really have to build the correct portfolio for that. I would focus less maybe on inflation per se and just ask myself — what is going to give me the growth over those 60, however many years, as long as I live, that my portfolio is preserved and gets bigger and I can sleep well at night?

Doug Fabian:   
Great, thank you.

Don Calcagni:   
Let me add to that if I may, let me add to that just very briefly.

Doug Fabian:   
Please.

Don Calcagni:   
I think it’s important to outperform inflation over time, not every time. I’ve spoken with clients over the years where they’ll look at what inflation was this month or even over the past 12 months. That’s completely the wrong way to think about it. You want to think about inflation over time not every time. There’s going to be times when inflation is running really hot for a given month or even for a given year but what’s important is that you outperform that over time. I want to echo strongly what Mari just said around, you have to have a portfolio that is geared towards growth. That is how you will outperform inflation over the long-term, is by having a portfolio that has a healthy allocation to global stocks and not just a portfolio that’s overly lopsided with bonds and CDs. It will be harder to outperform inflation with those types of investments, having too many of those in your portfolio. So, Doug.

Mari Adam:     
Right.

Doug Fabian:   
Let’s talk a little bit about the tax environment. It seemed just a couple of weeks ago it looks like there was going to be some tax legislation that was going to impact our clients this year. It appears as though much of that is moving out into the future. Mari, how are you handling, and I know that there’s uncertainty but how are you handling the tax discussion? What kind of coaching are you giving clients? And then, Don, I want to go to you with the same issue on taxes.

Mari Adam:     
It’s such a great question because we’re within 60 days or so of the end of the year and we just don’t know what the legislative environment will be next year. There is a lot of uncertainty and there are ways you can adapt yourself to uncertainty and the truth is we don’t know. Here’s some thoughts that I would certainly raise with clients. Right now, the tax regime is quite low, whether it’s taxes on income or taxes on capital gains. It’s always possible they may go lower but I would say it’s not very likely. One of the best things you can do as an investor is every year, harvest some gains especially if needed, to rebalance your portfolio. Don’t let these positions build up and up and up to the point where you can no longer sell them or manage them because you don’t want to incur the gain. Definitely be proactive every year and manage the gains in your portfolio.

Do take advantage of techniques like Roth conversions. I would never recommend to a client they do a huge conversion unless they really have extenuating circumstances. What we try to do with clients is have them do smaller conversions every year. Stay flexible. We try not to make big bets in clients’ portfolios or with strategies. I always like to do things that can be undone if needed. You have to look as an investor and say what’s the upside to making this decision and what’s the downside and weigh those. But I would urge people to take advantage of deductions now that they have before year end. Do those Roth conversions and certainly manage the tax liabilities in your portfolio by discussing that with your advisor.

Doug Fabian:   
Don, your thoughts on taxes and the tax environment going forward?

Don Calcagni:   
Yeah. Just to pick up where Mari left off, I think it’s important to draw a distinction between what we can control versus what we can’t control. None of us can control tax policy, right. I mean, we all get to exercise our one vote but that’s it, right. At the end of the day, what you can control is your portfolio, how diversified it is and so on and so forth. I do want to echo what Mari said, slowly harvesting those games every year, I think, is important. The reason why I think that’s important is it’s my view that taxes absolutely will be higher in the future. They have to. I think it’s math. Right now, the federal deficit is at 1.2 trillion dollars. That’s what it is this year. By the way, that is down dramatically from where it was last fiscal year which was close to $4 trillion. The US federal government has almost $30 trillion in outstanding debts which quite dramatic.

As interest rates rise, that’s going to put even more pressure on the federal budget. We have an aging populace. We’re trying to modernize our military. We’re trying to modernize our infrastructure. There is no lack of demands on the federal government’s purse. To me, it’s just math that taxes have to go higher in the future if indeed we’re going to be able to do all of these things that we want to be able to do as a society. To me, it’s just simple math. It’s a when, it’s not an if. The fact that at the moment, it looks like tax increases are off the table, I would take that as a gift that we have a longer runway perhaps to make any changes that are needed to our portfolios, to our balance sheet, to our estate plans, to do those things now before it may ultimately be too late.

Doug Fabian:   
Mari, a basic question from a client on inflation. You as an advisor, what inflation rate do you put into financial plans? Obviously, we have the ability to be able to change that rate. Different advisors can use different rates but what do you use and why?

Mari Adam:     
Well, for many years, we have benefited from really pretty low inflation. So, we were able to use lower rates and I think a common number might have been around 3% or something for most people. Keep in mind though, you have things like health care which is consistently inflated much faster, higher education, services like insurance. Depending on the person you’re working with, you may definitely want to use a higher inflation rate. But I don’t think in the past few years, it paid to overstate inflation. It just really has been somewhat dormant.

This is a new experience for many people that we actually are getting some serious inflation again. The last time I remember it happening was probably when I was in middle school or something or back in the Jimmy Carter era. You should certainly use a custom rate or ask your advisor to use a higher rate if you feel that’s appropriate. But I think looking at the spike in inflation now, it is likely that it will kind of settle down again. I don’t think anyone who’s anticipating 10% inflation or 5% inflation, I don’t think that’s really in the card. You don’t want to make too much of this. I think it is a dislocation because of COVID and it will settle down probably at that 3 percentage level after this.

Doug Fabian:   
It’s always interesting, and we see this more in the dynamics of the markets, people have a tendency to look at the most recent past. The most recent past, we’ve had have a very big spike in inflation. We have a year-over-year number of 5%. We have a tendency just as human beings, to project forward. Well, next year’s going to be at 5% and the year after it’s going to be at 5% and that’s just not reality. I just wanted all of our clients and listeners to keep that in mind that there’s going to be changes. There’s still some inflation in the pipeline. Don, question came in about supply chains. We’ve all seen the video footage and having been… I used to live in Huntington Beach California and all those storage ships are right off Huntington Beach. There’s 73 of them right now but just talk about this supply chain and what’s happening there and really, that’s kind of adding to the inflation picture right now.

Don Calcagni:   
Yeah. It’s definitely, I would argue, the most important variable at the moment in terms of inflation, right, is all of this disruption to supply chains, like you mentioned all the container ships off the coast of California. The reality is labor markets are exceptionally tight. Part of the problem with all of those container ships off the coast of California is that we don’t have enough truck drivers. By the way, they have the same problem in the United Kingdom with respect to their energy crisis at the moment. A lot of that has to do with the fact that they just don’t have truck drivers to transport things like energy and goods and services. A lot of this is labor market driven.

I think one of the things economists are a little bit befuddled with at the moment is the fact that a lot of these unemployment support programs they rolled off between July and September and for some reason, we have not seen a flood of new participants into the labor force. That’s something, I know economists are going to be spending the rest of their career trying to understand why are we not seeing more workers come into the labor force at the moment. But that’s a big part of it, Doug, is if you don’t have the bodies, the people that you need to run oil rigs, to work in restaurants, to drive trucks across the country, this is the real economy. If we don’t have people willing to do that for whatever reason, maybe they took jobs elsewhere, maybe they’re maybe they’ve built up a nest egg.

Whatever the reasoning is, if we don’t have those folks, that’s going to really create a compounding problem throughout supply chains. Some folks are pointing to commodities as being part of the problem, significant commodity demand. I think that’s part of it but I would remind all of us lumber has come down about 50%, iron ore prices are down dramatically. I’m not sure that it’s entirely a commodity story. I think it’s more of a labor market story globally that is explaining why we have all these supply chain problems. Even in continental Europe at the moment, labor markets are tighter than they have been and that is not a problem that continental Europe has had for quite some time. I think this is a global problem. It’s not necessarily unique to the United States.

[Crosstalk 00:57:07]

Mari Adam:     
Doug, this is definitely a real life problem as we’re talking with clients all day long, I’m hearing things like, “I’m working seven days a week because I can’t hire anybody. I have too much business that I can’t handle.” Or people saying, “I have a new house and I can’t get appliances for a year.” You’re seeing these disruptions both in the labor market and the supply chain that are really having effect on real people’s everyday lives. It’s not just the headlines. We definitely see it every day talking to clients and microcosm.

Doug Fabian:   
Mari, I wanted to come back. We had a, it’s kind of a specific question regarding Roth IRAs but I think it’s important because we want to continue to educate all of our clients on the rules of Roth IRAs. The client is asking the question — well, if you have a Roth IRA and you go to make a withdrawal prior to age 59 and a half, isn’t there a penalty there? If you could explain just some of the withdrawal rules regarding Roths because they are unique.

Mari Adam:     
If the question is can I make this sound easy, no, they are very convoluted rules. Here’s a real short version. If you make a Roth contribution, and this is always very misunderstood, a Roth contribution, new money, you pay tax on it, you put into your Roth, you may withdraw that money at any time without penalty, without tax, which makes the Roth IRA an ideal kind of a investment/savings account for younger investors. Contributions, you can always get out free, no problem. This question though is really referring if you make a conversion, if you take money out of an IRA for example and put it into a Roth, at that point, you are running into these rules that are either the 5-year rule or the 59 and a half.

The rules can get a little complicated and this is part of the problem. All these things we deal with are just so convoluted. It’s unfortunate because if people understood them more, they would be able to take better advantage but these are all questions for your advisor. Let them orient you to doing the right contribution or the right plan to really put you on the right path.

Doug Fabian:   
Excellent, Mari. Thank you. That was great feedback. We’re coming up on the top of the hour. A couple of things I just want to remind everyone of. We are going to post this webinar like we do all webinars to our website merceradvisors.com under the Insights tab. Takes a couple of days for us to convert the file and the like but we’ll get this recording up there. If you came in mid-stream or you had to leave early, we’ll definitely get the recording posted. I just wanted to go back to Don, you and Mari for just some closing comments today on what you feel as though were the key takeaways for clients. Don, let’s start with you.

Don Calcagni:   
I think the key takeaway for clients is that — look, the economy is, it’s large, it’s complex and it’s ever-changing. By the way, we can say the same thing with respect to tax policy. The reality is the world is constantly changing. Because it’s constantly changing, we should work with our advisor. Let’s reassess our risk tolerance, let’s reassess our financial plan. I love what Mari said a little while ago about basically always having the flexibility to undo something. Always being able to pivot as conditions on the ground change, I think, is critically important. We shouldn’t be upset or angry with the fact that things are changing. That’s life. Things are always changing. But we should be working closely with our advisors, make sure our plans, make sense make sure our portfolio reflects our circumstances and from there, you can be more proactive and better prepared to deal with the change that will inevitably come in the future.

Doug Fabian:   
Mari, any closing thoughts from you?

Mari Adam:     
Here’s my two cents. We talked about some bad things like higher interest rates and higher inflation but I would say take a deep breath. These are the trees but let’s look at the forest. We have very low interest rates and even with the rate increases coming, I’m going to lay my bets, they’re going to stay awfully low. I think inflation will too in comparison to where it has been in the past. Don’t listen to this and think the world is a bad place or a scary place to invest. It’s not. It is changing but these are all very manageable and I can assure you that these are things we all have our eye on and looking for solutions for your portfolio and your financial plan.

Doug Fabian:   
Excellent, Mari. Thank you very much. Ladies and gentlemen, we appreciate you being a client of Mercer Advisors. Again, we want to invite you to reach out to your specific advisor to get commentary about your situation and we look forward to meeting with you again in January when we do our next quarterly webinar. Thank you very much for joining us and have a great day.

Mari Adam:     
Thank you, goodbye.

Don Calcagni:   
Thank you, everybody. Goodbye.

View the Full Transcript

Talk with a Local Advisor

Related Topics:

Talk to Us.