BEWARE THE WEAK LINKS
The financial press and many market prognosticators have been predicting a U.S. recession “at any minute” for the past 18 months. Despite market declines in 2022 due to aggressive interest rate hikes by the Federal Reserve and other global central banks to combat inflation, the economy has avoided a recession, which has yet to materialize in 2023. When the next recession does occur (and it will), we think it will start elsewhere.
Fifteen years ago, the Great Recession was triggered by widespread bank failures, due to consumers taking on unsustainable real estate leverage. This was accompanied by lackluster government regulatory oversight, policy enablement and financial institutions that extended too much credit to lower creditworthy borrowers through subprime loans. Property values initially soared, then reached a pinnacle, leading to widespread foreclosures, loan defaults, and bankruptcies that sparked a global economic downturn and a subsequent pullback in consumer spending.
In the decade and a half since the Great Recession in 2008, both American and European consumers have significantly scaled back their expenditures. They’ve focused on reducing their debts, bringing their debt-to-income ratios down to levels considered sustainable by historical standards. Corporations, as well as consumers, have paid down and refinanced their debts at very low interest rates.
Today both groups, corporations, and consumers, are in much better financial shape, after lowering debt ratios and refinancing at historically low interest rates. However, it is the government that has embarked on a borrowing and spending binge that contributes to inflation and higher rates.
We believe the next recession is more likely to originate outside of the U.S., with Canada, Sweden, Norway, Australia, New Zealand, or the United Kingdom as potential starting points. These “weak link” countries share a common trait: they seem to have missed the lessons about real estate leverage from 2008. Using Canada as an example, they have seen a steep rise in household debt, now 185% of disposable income. Rising debt-to-income ratios in these economies are a cause for concern and an area of weakness which warrants monitoring.
Weak Link Economies Have High Amounts of Household Debt
The United States and Europe, having restructured their financial systems over the past 15 years, are in a stronger position to withstand higher interest rates compared to more leveraged nations. There is concern that financial strain on these overleveraged countries may trigger a domino effect, potentially leading to a broader economic downturn.
The Federal Reserve’s strategy to combat inflation involves quantitative tightening (QT) and the hiking of interest rates, which risks pushing highly leveraged countries into economic contraction due to their inability to cope with rising rates. It is anticipated that the Fed may need to further increase rates in the upcoming year. This could occur if the global economy maintains its growth trajectory, potentially exacerbated by recoveries in China and Europe, which would contribute to more persistent inflation.
There is also a belief that the Federal Reserve has misjudged the neutral interest rate, or R-Star, due to reliance on economic conditions from the past 15 years which were influenced by the Great Recession and subsequent economic stimulus. This may have led to an underestimation of the current economy’s sensitivity to rate hikes, especially since consumers and corporations have significantly improved their balance sheets since 2008.
After a decline in the third quarter where long-term interest rates rose above 5%, the stock market has found firmer ground. This previous downturn was in part due to the need to address a forecasted $1.7 trillion deficit amid robust government spending and additional outlays from the conflict in Israel.
The stock market’s revival aligns with a bond market rally, which saw interest rates pull back from their peak to 4.5%, easing borrowing costs. Despite lingering recession concerns and earlier calls for lower rates, it’s this shift in the bond market that underpins the recent stock market rally. With a reversion to a bond bear market anticipated next year, we might see a subsequent impact on Canadian real estate, as well as the broader bond and stock market due to rising rates.
TAX-LOSS HARVESTING AS YEAR-END APPROACHES
As the calendar year draws to a close, we review taxable accounts and look for opportunities that can potentially reduce your current or future tax liabilities. This process is called tax-loss harvesting.
What Is Tax-Loss Harvesting? Tax-loss harvesting involves selling securities at a loss to offset capital gains tax liabilities.
Capital Gains and Tax Implications: Capital gains taxes are incurred when you sell an investment for more than you paid for it. These are taxable for the year in which they are realized. However, if you have investments that have lost value, selling them can offset these gains.
Carry Forwards – A Strategic Reserve: One of the most significant aspects of tax-loss harvesting is the ability to carry forward these losses indefinitely. If your capital losses exceed your capital gains, you can use up to $3,000 of excess loss to offset other income for the tax year and carry forward any remaining losses into future tax years. We believe it is beneficial to realize losses opportunistically and save them to offset future gains.
We actively manage portfolios with a view towards tax efficiency, including the consideration of tax-loss harvesting where appropriate. This involves reviewing your investments to identify any that are positioned for this strategy as we near year-end.
Tax-loss harvesting is one of many strategies used in comprehensive portfolio management. It should be considered within the context of your overall investment strategy and we encourage you to reach out with any questions.
2024 CONTRIBUTION LIMITS: IRAs AND 401(K)s
For those contributing to employer-sponsored retirement plans and IRAs, key dollar limits are set to increase in 2024. Contribution limits to 401(k), 403(b) and 457 plans rise to $23,000. Additionally, for those age 50 and older you can contribute an extra $7,500. For SIMPLE IRA plans, the limit rises to $16,000, plus an additional $3,500 for those age 50 and older.
For Traditional and Roth IRAs, the contribution limit increases to $7,000. There is an additional $1,000 catch-up contribution for individuals 50 and older.
For those interested in contributing to a Roth IRA, the income ceiling is also set to increase in 2024. For single filers, contributions phase out for 2024 at adjusted gross income between $146,000 and $161,000. For joint filers, the phase out is between $230,000 and $240,000.
QUALIFIED CHARITABLE DISTRIBUTIONS (QCDs) – NOW INDEXED FOR INFLATION
IRA owners age 70 ½ and older can now transfer up to $105,000 (up $5,000) directly to charity to satisfy a portion of their Required Minimum Distribution (RMD) in 2024. The previous limit was $100,000 but the cap is now indexed for inflation and will adjust higher in future years. QCDs are not taxable and are not included in your adjusted gross income.
MEDICARE NOTES
For 2024, Medicare Part B’s standard monthly premium is set at $174.70. However, seniors with higher incomes will face increased premiums for both Part B and Part D if their modified adjusted gross income (MAGI) for 2022 surpassed $206,000 for joint filers or $103,000 for single filers. To clarify, MAGI is your adjusted gross income (AGI) plus any tax-exempt interest income.
Individuals in this upper-income bracket will not only pay the standard Part B premium but also an additional surcharge. The same applies to their Part D prescription drug plan premiums. The accompanying table outlines the extra costs for those with higher incomes.
Married seniors filing separately should take particular note: if they lived with their spouse at any point in 2022 and their MAGI was over $103,000, their total monthly premiums for Part B can range between $559 to $594. Additionally, Part D surcharges will range from $74.20 to $81 monthly, depending on their MAGI level.
There’s potential for relief, though. If your financial situation has significantly changed since 2022 due to events such as divorce, the death of a spouse, retirement, or other major life changes, you might be eligible for a reduction in these surcharges. To seek a reduction, submit Form SSA-44 to the Social Security Administration outlining your changed circumstances.
FINAL THOUGHTS
As we close out the year, the U.S. and Europe stand resilient amidst global economic uncertainties, but vigilance is key in monitoring potential “weak links” in the global economy. For portfolios we will continue to look for strategic tax-loss harvesting opportunities in the month ahead. We wish you and your families a peaceful and joyful Thanksgiving. Please reach out with any questions or if we can be of service.