InSight

Market InSights:

When does a Bear look like a Bull? (Pt. 2)

When will a Bear-Market Rally form a New Bull?

The market will turn around, they always do, some would argue that they are built to expand. Below are some of the elements we look for to determine if a market is turning around, or if we are looking at another Bear Rally. 

Rallies will get longer in time, and less dramatic 

The drama of a bear market is exciting and news outlets love it. The markets and the news gravitate towards those chaotic headlines. This was easily seen when during the last Bull market news outlets ran headlines and talking heads marking the top, declaring market “warnings” and finding economists that would deride the market. It’s exciting and captures eyeballs…the turnaround won’t be all that exciting. 

There won’t be a day of major capitulation, followed by a counter move to the upside. It will come with steady, long-term grinds up. It will come with the whole market moving up in a coordinated and cooperative way. Markets with a broad influence from several sectors that grind out small moves over a long time are far more attractive to investors and generate a virtuous cycle. 

The Bear Rallies of 2022 so far…

 

Days

Percent

Daily %

Bear Rally (1)

9

6.1%

0.67%

Bear Rally (2)

11

9.9%

0.90%

Bear Rally (3)

12

6.2%

.51%

Bear Rally (4)

41

14.3%

.34%

Bear Rally (5)

?

?

?

The median gain of the largest rallies that have occurred within bear markets is 11.5% over 39 days. Typically, the rallies on the low side of the median, occur early in the bear market, while those that exist on the high side are in the more mature parts of the bear market.

Additionally, there are far more rallies below the mean, than above. Meaning that we will see more false rallies that are short and volatile and only a few long-term sustainable rallies that are long with small moves.

The longer these rallies get, and the smaller the moves, the more likely an “all clear” can be declared. 

There will be broad support  

Investment professionals look for certain technical signals to be in place before confirming a reversal is underway. There are several measuring sticks that look for broad support in trading. The advance-decline line, trades above the moving average, and the McClellanOscillator are examples of technical measurements of the breath the market is moving, for how many stocks and how many sectors are participating in the move. 

“Breadth thrust” is the term for these signals, and a leading indicator if a market is transitioning from a Bear to a Bull. The duration of the move and the price gains associated with it are also important. The indicators that most reliably confirm that there is a shift into a new bull market are:

Flows into equities and out of cash in important ETFs

There are “traders” ETFs, and there are “investors” ETFs, and knowing the difference is important.

If dollars are flowing into leveraged high volatility trading products it is a signal that the market is trading for a short-term and volatile swing (read a bear rally). If money flows are going into long-term holds that cover the whole of a market in balanced and long-term ways, it’s a signal that the investment appetite is changing to a more long-term outlook and investors are building a new core of their profile. Outsized flows into SPY, QQQ, or VOO are a good sign that the broad market is healthy and investors are willing to hold the whole of the market. 

The current market is witnessing the worst first half for stocks and bonds in 50 years, the highest inflation in 40 years, and an endless barrage of bad economic data. So seeing a broad, coordinated shift from cash and cash-like funds, into broad equity will be a good sign in a change from “risk off” to diversified “risk on”.

Earrings being “better than expected” at more and more companies

There is an entire industry reporting on “beats and misses” on companies’ earnings. While individual stock stories are exciting and reported on the news, the sizes and frequency of misses vs. beats are often overlooked. 

Wall Street pros are at odds as to whether we are at an inflection point in the markets. That inflection point will be confirmed when estimates, which are increasingly bleak, are replaced by corporate earnings that are better than expected. This will take several quarters and is a laggard indicator. But is the most reliable measurement to say the companies that make up the market are in a healthy and expansionary space. This seachange in earnings will likely happen 2-3 quarters after the market has “bottomed”, so while not a great trading and timing indicator, it is a very good indicator of changes in the macroenvironment.

Company earnings are a more reliable indicator of investment health, this is not a shocking revelation. But the frequency and diversity by which these companies manage inflation pressures, and sell their product to the marketplace is a tide that raises all boats and encourages board participation in rising stock prices. 

What past Bear-Markets tell us about future ones

A peek at the history of bear markets would suggest that the “naysayers” are on the right side of history, at least for a time. In the 30 different bear markets that have occurred since 1929, the stock market registered an average decline of 29.7%. These downturns lasted have lasted for an average of 341 days. 86% of the bear markets last less than 20 months, and few last longer than one year.  

Right now, according to traditional economic interpretations, the U.S. could well be in a recession. We have seen two-quarters of GDP contraction. The Commerce Department reported that gross domestic product shrank by 0.9% in the second quarter of, after contracting 1.6% in the first quarter of this year. That’s it, that is the traditional definition of a recession, and the Bear market has priced that move in as a result. 

So why the “is this a recession this time” talk? Well, there has been a rash of different pro-growth data that has persisted. Wages have grown, unemployment has stayed low, and demand for freight, semiconductors, and component raw materials has been high. These would indicate that demand is still healthy. How can you have a recession with such a demand for materials? 

If the Fed can achieve the delicate balance of taming inflation by slowing the economy without tipping the country into a recession, this bear market could already be long in the tooth. If we count the correction from the November high, we will be entering the second year of the bear market next month. The one-year mark for this Bear market would come in March of 2023 (just around the corner by economic standards – meaning we are currently in the 3rd or 4th inning of the Bear Market with the most violent changes in pricing behind us. This would be an “un-recessionary bear market”

If the Fed fails in a “soft landing” in the first quarter of next year more reliable indicators of recession (falling commodity prices, major spikes in unemployment, and weakening manufacturing outlooks) are on the rise before the Fed quells inflation then we can see a more elongated bear market and a full-blown recession. 

More related articles:

boulder colorado financial advisors, financial planning and risk management
Articles
Kevin Taylor

Section 1031 Exchange and Your Primary Residence: How They Can Work Together

When it comes to a 1031 exchange, your primary residence is generally excluded. According to the rules of Section 1031 of the Internal Revenue Code (IRC), property used for personal purposes, like a primary residence, doesn’t qualify for tax deferral. The law only applies to properties that are “held for productive use in a trade or business or for investment.” However, there are situations where your primary residence is part of a property with business or investment land, and in these cases, a Mixed-Use 1031 Exchange may apply. Mixed-use property and a 1031 Exchange A mixed-use exchange happens when the property being sold includes both a primary residence and land or structures used for business or investment purposes. Part of the property may qualify for a 1031 exchange in these scenarios, while the residential portion could be eligible for Section 121 benefits (more on that in a minute). Examples of mixed-use properties include: A home office where a business rents space in your house. A farm or ranch where you work the land as a business but live on the property. A duplex where you live in one unit and rent out the other. A single-family home with an accessory dwelling unit (ADU) that you rent out while living in the main home. As long as part of the property is used for business or investment, it could potentially qualify for a mixed-use 1031 exchange. The IRS Code: Section 1031 and Section 121 Here’s the breakdown: Section 1031 allows you to defer capital gains taxes on properties used for business or investment when you exchange them for similar properties. Meanwhile, Section 121 allows homeowners to exclude up to $250,000 ($500,000 for joint filers) of capital gains on the sale of their primary residence if they’ve lived there for at least two of the last five years. So how do you take advantage of both sections? It’s all about identifying your “principal residence”—which is typically your primary home (not your vacation home). Your primary residence can also include parts of a property that are used for business or investment. Key Questions About Combining Sections 1031 and 121 How is the Section 121 exclusion calculated? The calculation of the exclusion for your primary residence involves determining the original purchase price of your home, the cost of improvements, and the value of the residential portion of the property being sold. You can determine the value with a market analysis from a realtor or an appraisal. For joint filers, the exclusion can be up to $500,000, while single filers get a $250,000 exclusion. A common issue arises when a property has both a personal residence and a 1031-eligible business portion, and no value is explicitly allocated between the two. A current market analysis or other valuation methods can help. Consider factors like the per-acre value of the residential part compared to the larger investment property and the home’s insurance value. How is the homesite defined? When valuing the residential portion of a mixed-use property, it’s helpful to think of the land and features that contribute to your enjoyment of the home—this could include gardens, septic systems, small pastures, and more. Using aerial photos is often a smart way to determine the homesite’s boundaries and help make the valuation more precise. A Hypothetical Example Let’s walk through a simple example: Total sale price: $2,500,000 Residential portion: $800,000 Basis in the primary residence: $300,000 Section 1031 portion: $1,700,000 In this case, the primary residence portion is valued at $800,000, so the taxpayer could exclude the gain on that amount (up to $500,000 for joint filers, $250,000 for singles). Applying the 121 Exclusion to Debt Payoff One of the benefits of using the Section 121 exclusion is that you don’t have to reinvest the sale proceeds in another property. If there’s debt associated with the property, the Section 121 exclusion can help cover the debt payoff. In our example above, if the taxpayer owes $500,000 in debt, they can apply the 121 exclusion to cover that, meaning they don’t need to replace the debt with new debt in the 1031 exchange portion of the transaction. How is the 121 Exclusion Documented? The key to documenting the allocation of proceeds is ensuring there’s a clear separation between the 1031 exchange portion and the personal residence exclusion. The settlement statement from the sale will have line items showing both: one for “cash to exchanger (personal residence)” and another for “exchange proceeds to seller” (handled by the qualified intermediary). When Doesn’t Section 121 Apply? Section 121 won’t work if the property is part of a business held by a corporation or partnership—since these entities can’t own a primary residence. However, if you’re an individual or a disregarded entity like a single-member LLC or sole proprietorship, you can use the exclusion. It’s also possible to distribute the personal residence out of a business entity before the sale, but you’ll need to plan ahead—this needs to happen at least two years before the sale. Final Thoughts The Section 121 exclusion can give you a significant tax break by putting cash in your pocket without the need to reinvest. For mixed-use properties, taxpayers can use the Section 121 exclusion for the residential portion of the sale, while using Section 1031 for the business or investment portion. Keep in mind, though, that when participating in a 1031 exchange, your intent must be to hold the replacement property for productive use or investment in the long term. It’s crucial to consult with a tax or legal advisor when structuring a 1031 exchange or when considering any changes to your investment property.

Read More »
Articles
Kevin Taylor

Using a Delaware Statutory Trusts (DST) with 1031 Exchange Investments

Delaware Statutory Trusts (DSTs) are extremely popular with 1031 exchange investors. In addition to the tax mitigation aspects of the 1031 itself, they allow investors to diversify the make-up of an investment portfolio, access new buildings and investment types, and easily scale up or down the size of their real estate portfolio. 1031 exchange investors favor DSTs due to the fact that it can be difficult to identify a replacement property within 45 days and in most cases, the DST can accept the exact balance investors are looking to replace a part of the 1031 Exchange. What is a Delaware Statutory Trust? The name will usually confuse new investors. The “Delaware” in Delaware Statutory Trusts is simply a component of the law being initially conceived and developed in Delaware. A common state for incorporation and legal standing. The use of the DST structure helps keep the title clean in connection with ownership by many co-investors. It separates the investor holding title individually into a holding in a new trust where the investor is the beneficial owner. The trustee of the trust can take actions on behalf of the trust beneficiaries (i.e. the DST investors/owners) which does not require agreement by all. Why invest in a DST? Few investors have the requisite net worth to own a 30-story office complex and keep the real estate exposure for their portfolio in line with their risk expectations. That is where the use of DSTs comes into play. A DST is attractive to an investor who desires access to a single property or portfolio of high-value, high-quality real estate asset(s) that may not otherwise be available to them due to size or service constraints. A DST puts the management and ownership of a real estate venture into a manageable box for most investor types. Collecting income, managing taxes, and maintaining the risk are all far easier in the real estate space through the DST structure. The investor receives a deeded fractional ownership in the property in a percentage based upon the equity invested. Is a DST like a REIT? It has some characteristics of a REIT or Real Estate Investment Trust but is different, including the fact that it is often, but not always, just a single property. In addition, the owner of REIT shares holds a partnership interest in the underlying real estate investment. Partnership investments do not qualify for 1031 exchange investments, even if the underlying asset consists of real estate. How does the DST provide income? Similar to the other real estate investments, DSTs generally pay monthly or quarterly an amount based on the excess rent over the property expenses. This includes any mortgage payments so as the debt service is paid, the equity ownership of the investor shifts as well. The Return on Equity (RoE) varies from deal to deal based on the specifics of the property, the building type, and financing goals. With most deals, the sponsor knows the net rent that can be expected and can give the investor the anticipated return for the term of the investment. How long does the DST operate? Most DSTs have a well-defined expectation for liquidation of the asset. The asset’s holding period varies and is prescribed in the beginning, but most have an intermediate time frame. Usually, 3-7 years and the investor shares in the same percentage basis the appreciation in value upon sale of the property. How does the liquidation work? This final stage of a DST is a complete liquidation of the Real Estate assets. This is also part of the investor’s stake in the holding. This can increase the overall annualized return by a couple of percentage points and is paid out in cash upon liquidation. While most investors seek out real estate for the prospect of a current and predictable income – tax mitigated capital appreciation as part of the real estate investment is typically the larger portion of the total return of the investment. Who can buy into a DST? The manner in which DSTs are marketed to the public has a lot of characteristics of sales of securities. Over time, the SEC decided to regulate them as actual sales of securities. So, although a DST interest retains the nature of real estate ownership, with some exceptions, they are regulated. They are typically brought to market for syndication by large well-known sponsors, although they have to be acquired through a Broker, Registered Investment Advisor, or a licensed Financial Advisor. The DST structure usually, if not always, requires the investor meets the Accredited Investor standard as the offerings are listed through the Reg D issuing process. Typically, the broker or advisor will vet all offerings of the sponsors with whom they have an agreement and that level of due diligence is a benefit to the investor who is unlikely to have the wherewithal to review the investment as closely.

Read More »
Articles
Kevin Taylor

Divorce Playbook: When Should You Consider Mediation 

Alternatives to the courts for legal separation are called mediation and determining early on if this arrangement is right for you can be important to moving forward. The relationship you have with your spouse might determine much of this, but the expected outcome is what is most important. Mediation does not substitute having or using a lawyer as part of the process. But if you and your spouse can work together to reach a fair settlement on most or all of the issues in your divorce (eg., child custody, child support, alimony, and property division), choosing mediation to resolve your divorce case may save thousands of dollars in legal fees and emotional aggravation. The mediation process involves a neutral third-party mediator (an experienced family law attorney trained in mediation) that meets with the divorcing couple and helps them reach an agreement on the issues in their divorce. Every mediation firm will have its process for working through issues, both financial and legal as they separate assets. It’s important to have a good understanding of the current and future valuations of assets during this process and with a mediator who uses a financial expert to support these calculations.   Mediation is completely voluntary and this course can be abandoned in favor of the courts if the parties cannot agree, or if one or both parties are uncooperative. The mediator should not act as a judge, or insist on any particular outcome or agreement.  Mediation also provides divorcing couples a lot of flexibility, in terms of making their own decisions about what works best for their family, compared with the traditional adversarial legal process, which involves a court trial where a judge makes all the decisions. Mediation, however, is not appropriate for all couples. For example, if one spouse is hiding assets or income, and refuses to come clean, you may have to head to court where a judge can order your spouse to comply. Or, if one spouse is unwilling to compromise, mediation probably won’t work. The Complete Playbook

Read More »

Pin It on Pinterest