A cautious, upbeat start to 2023

There was no shortage of gloom as the new year began. The Federal Reserve was signaling higher interest rates, and its aggressive campaign, started last year, to rein in inflation has been threatening to throw the economy into a profit-killing recession.

While investor sentiment is far from euphoric right now, 2023 is off to a strong start, especially in the areas that underperformed last year. What’s behind the move?

Last year, the Fed hiked its key lending rate, the fed funds rate, by 75 basis points (bp, 1 bp – 0.01%) in four consecutive moves.  Mix in a 50 bp increase in December and 25 bp increase back in March, and we experienced the most aggressive tightening cycle in over 40 years—1,000 bp in 6 months (St. Louis Federal Reserve) at the end of 1980. Ronald Reagan had not yet been inaugurated.

While the Federal Reserve is not yet signaling a halt to rate hikes and commentary suggests it could hold rates at a high plateau this year (what analysts have been calling ‘higher for longer’), the pace of rate increases is set to slow from last year’s nearly unprecedented level.

But are investors front-running the Fed? Or are they too optimistic about rates? Fed officials pushed back aggressively last year on a 2022 pivot.

Today, investors believe we may see at least one rate cut by the end of the year. Previously, that had not been in the Fed’s game plan, but Fed Chief Powell seemed less wedded to pushing rates above 5% at the February 1 press conference. While Powell isn’t declaring victory on inflation and he isn’t ready to hint at a turnaround, he was more open to the recent moderation in inflation. The initial reaction was positive.

Looking ahead, a significant rise in the jobless rate would probably force the Fed to cut rates, but a drop in corporate profits could negate any benefits from falling rates. How the Fed responds will be heavily influenced by how the economic outlook unfolds.

A cloudy crystal ball

From 1970 through 2021, the January return on the S&P 500 Index exceeded 5% 10 times (St. Louis Federal Reserve data). Excluding reinvested dividends, the S&P 500 finished the year higher nine times. The 90% ‘win ratio’ beats the average since 1970 of 74%.

During the 10 years when January advanced by 5% or more, the S&P 500 averaged a return of 21.5%. Its best annual return was 31.6% in 1975, which followed the difficult 1973-74 bear market. Its only loss was 6.2% in 2018.

There are those who attempt to glean insights from expected market returns based on where we are in a political cycle. Such exercises are interesting, but let’s stress that each economic cycle has its own peculiarities that may override these barometers. We know that past performance is not a guarantee of future results. Ultimately, the economic fundamentals will play a big role as the year unfolds.

2023 Changes to Retirement Plan Contribution Limits and Tax Details

We covered this last month and some of it in a tax update email, but still getting questions on the many tax and retirement contribution changes for 2023:

The theme for 2022 was definitely inflation and the negative impacts to the economy as well as stock and bond investments due to the Fed raising rates to try to stop inflation’s impact.  While definitely not offsetting the impact of actual inflation, there are some beneficial items in the retirement plan contributions and tax-bracket/tax-credit areas

401(k), 403(b), 457 plans, and Thrift Savings Plan

• The amount individuals can contribute to their 401(k) plans in 2023 has increased to $22,500, up from $20,500 in 2022. 

• The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the federal government's Thrift Savings Plan has increased to $7,500, up from $6,500. 

• In total, participants 50 and over can contribute up to $30,000 ($22,500 + $7,500) beginning in 2023.

Traditional and Roth IRA

• The limit on annual contributions to an IRA increased to $6,500, up from $6,000 in 2022.

• The IRA catch-up contribution remains $1,000 for individuals 50 (and is not subject to an annual cost-of-living adjustment).

• The income phase-out range for taxpayers making contributions to a Roth IRA has increased to between $138,000 and $153,000 for singles and heads of household, up from between $129,000 and $144,000. 

• The income phase-out range has increased for married couples filing jointly to between $218,000 and $228,000, up from between $204,000 and $214,000.

Amid historic (and stubborn) inflation, the IRS has announced higher federal income tax brackets and standard deductions for 2023. The announcement may mean savings for Americans in all income brackets—welcome news as rent, gas, and grocery prices soared to 40-year highs.

That said, here are a few key changes to note as we enter a new tax year:

• Federal income tax brackets will increase by roughly 7%, allowing taxpayers to shield more of their hard-earned income from taxation. For example, single taxpayers earning $44,726 to $95,375 will pay $5,147 plus 22% of the amount over $44,725. Married taxpayers filing jointly making $89,451 to $190,750 will pay $10,294 plus 22% of the amount over $89,450. Outside those brackets? You can find your 2023 tax bracket information here.

• The standard deduction is increasing from $25,900 in 2022 to $27,700 for married couples filing jointly and from $12,950 to $13,850 for single taxpayers.

• The earned income tax credit amount will jump to $7,430 for qualifying taxpayers with three or more children, up from $6,935 for tax year 2022 (IRS).

• The new IRS limit for FSA contributions for 2023 is $3,050, an increase of 7% from 2022’s threshold of $2,850.

• Taxpayers will be able to give up to $17,000 in gifts in 2023 without paying taxes, up from $16,000 in 2022.

• The IRS will exempt up to $12.92 million from the estate tax, up from $12.06 million for people who died in 2022—another increase of roughly 7%.

• The tax changes come days after the government announced that millions of Social Security recipients will get an 8.7% boost in their benefits in 2023—an average of $140 per month.

• Keep in mind that these changes are for the 2023 tax year and will have no impact on the taxes you file in April. That said, now is the perfect time to begin considering tax strategy as the 2023 tax year approaches. 

In our current inflationary environment, these changes and boosts in benefits are small but strategic ways you can mitigate inflation's lingering impact. If you have any questions or would like to discuss any matters, please feel free to give me or any of my team members a call.

As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor.

Jeff, Gabe, and your Phase Four team

Registered Representative offering securities and advisory services offered through Independent Financial Group, LLC (IFG), a Registered Investment Adviser. Member FINRA/SIPC. Phase Four Financial Solutions and IFG are unaffiliated entities.

No investment strategy can guarantee a profit or protect against loss. The market indexes discussed are unmanaged and generally considered representative of their respective markets. Individuals cannot directly invest in unmanaged indexes. Past performance does not guarantee future results. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost. Diversification does not guarantee profit nor is it guaranteed to protect assets. 

Thanks to Horsesmouth & Levitate for the data points listed above.  The information and opinions presented are for general information only and are not intended to provide specific advice or recommendations for any individual. You should contact your investment representative, attorney, accountant or tax advisor with regard to your individual situation. The opinions of the presenter do not necessarily reflect those of Independent Financial Group, LLC, its affiliates, officers or directors.

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