InSight

Financial Planning Dentist

InSight
Finacial
Planners

Menu

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. 

Continued from Part 1: When does a Bear look like a Bull? What to Avoid

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 »
February 25, 2025 No Comments
Articles
Kevin Taylor

The Growing Importance of Cash Flow in Real Estate Investment

For the past two decades, real estate investors have enjoyed the benefits of historically low interest rates. This environment of cheap money has led to significant growth in property valuations, making it easier for investors to achieve substantial returns through capital appreciation. However, as the economic landscape shifts, with borrowing rates now hovering above 5%, the traditional model of real estate investment is transforming. In this new era, cash flow will play an increasingly critical role in generating returns. The Era of Cheap Money and Its Impact on Real Estate The early 2000s through the 2010s were marked by an unprecedented era of low interest rates. Central banks around the world kept borrowing costs down to stimulate economic growth, making debt financing more accessible and affordable for investors. This influx of cheap money spurred rapid growth in the real estate market, with property values appreciating significantly over time. During this period, many investors focused on “capital growth”—the increase in the value of their properties over time. The strategy was straightforward: purchase properties, hold them for a few years as their values soared, and then sell them for a handsome profit. While this approach proved highly profitable in a low-interest-rate environment, it relied heavily on continuous and substantial appreciation of property values as part of the total return. This shift in the economic landscape has revealed that many individual or amateur property managers have historically been less focused on optimizing rent increases, often leaving significant money on the table. During the prolonged period of low interest rates, these property managers might have relied heavily on the natural appreciation of property values to secure their returns, paying less attention to maximizing rental income.  This oversight was less consequential when capital growth was robust and borrowing costs were minimal. However, in the current environment of higher interest rates, failing to strategically increase rents can result in missed opportunities for enhancing cash flow, making properties less financially resilient. As a result, these managers must now prioritize rent optimization to ensure their investments remain profitable and sustainable, shifting their approach from a passive to a more proactive management style. The Shift to Higher Interest Rates Today, the economic environment has changed. Central banks have raised interest rates in response to inflationary pressures, leading to borrowing rates exceeding 7%. Rising interest rates significantly impact the buy side of the property equation by limiting the bids potential buyers can make. Higher interest rates increase the cost of borrowing, which directly affects an investor’s ability to finance property purchases. When borrowing costs are low, buyers can afford to bid higher for properties because their financing costs are manageable. However, as interest rates climb, the monthly mortgage payments and overall debt servicing costs rise, reducing the amount buyers can reasonably offer. This tightening of the borrowing environment effectively lowers the maximum price buyers are willing and able to pay, thereby limiting the bids that come into the market. This trend of higher borrowing costs leads to fewer and fewer deep-pocketed buyers in the market, as the elevated interest rates make it more challenging to secure affordable financing. Consequently, many investors, particularly those with limited capital reserves, are priced out of the market. Additionally, institutional buyers and larger investors, who typically have access to more substantial funds, may also become more conservative in their bidding strategies to mitigate increased financial risk.  The result is a reduction in the number of transactions and a decline in the overall transaction values of commercial and residential properties. As the market adjusts to these new conditions, property valuations are likely to stabilize or even decrease, reflecting the reduced demand and lower bidding power of potential buyers. This environment of higher interest rates and tighter lending standards is expected to persist, influencing the real estate market dynamics for years to come. The Increasing Importance of Cash Flow In this new reality, cash flow—the income generated from a property after operating expenses and debt service—has become more critical. Here’s why: Stable Income Stream: Unlike capital appreciation, which can be unpredictable and influenced by market fluctuations, cash flow provides a steady and reliable income stream. This stability is particularly valuable in a high-interest-rate environment, where the costs of borrowing are higher. Financing and Investment Viability: Lenders are more cautious in a high-interest-rate market, often requiring stronger cash flow to justify loans. Properties that generate solid cash flow are more likely to secure favorable financing terms. Longer Holding Periods: With capital growth less pronounced, investors may need to hold properties longer to realize significant appreciation. During this extended holding period, cash flow ensures that the property remains financially sustainable and continues to generate income. Increased Rental Income: To offset higher borrowing costs and achieve desired returns, investors may need to raise rents. This approach not only enhances cash flow but also helps maintain the property’s financial health. Less Reliance on Leverage: High interest rates make heavy leveraging less attractive. Investors should use less debt and rely more on the income generated from the property itself. A strong cash flow can compensate for the reduced leverage, ensuring the investment remains profitable. Adapting Strategies for Future Success Investors must adapt their strategies to thrive in this new environment. Here are some key considerations: Focus on Cash Flow-Positive Properties: Prioritize properties that generate positive cash flow from the outset. Look for markets with strong rental demand and consider properties that may require some initial improvements to enhance their income potential. Increase Operational Efficiency: Manage properties more efficiently to maximize cash flow. This could involve reducing operating costs, improving property management practices, and leveraging technology to streamline operations. Consider Long-Term Investments: Be prepared for longer holding periods to achieve desired returns. Emphasize the importance of consistent cash flow over speculative capital gains. Raise Rents Strategically: While increasing rents can boost cash flow, it’s essential to do so strategically to avoid tenant turnover and maintain occupancy rates. Conduct market research to determine appropriate rent levels and consider value-added improvements that justify higher

Read More »
June 17, 2024 No Comments
Articles
Kevin Taylor

What Are the Benefits of a Safe Harbor 401(k) Plan?

A safe harbor 401(k) plan is a retirement savings plan that has advantages for both employers and employees. Here’s why it’s a good choice: Easy Compliance: Safe harbor plans help employers by automatically passing certain annual tests. These tests, like the ADP and ACP tests, ensure fairness in the plan and prevent favoritism toward business owners and highly paid employees. Failing these tests can be expensive, so passing them without worry is a big plus. Encouraging Savings: To meet safe harbor standards, employers need to make contributions to their employees’ accounts. This serves as an incentive for more employees to join the plan and rewards them for saving. Flexibility in Contributions: Employers have options in how they contribute. There are two plan types: traditional safe harbor plans with specific contribution formulas and immediate vesting, and QACA safe harbor plans with slightly lower matching contributions and shorter vesting schedules. Both types offer different contribution formulas, so you can tailor it to your needs. If you’re interested in setting up a safe harbor plan, contact InSight.

Read More »
November 15, 2023 No Comments

Pin It on Pinterest