Ladies and gentlemen, the weekend! In this space each week, Greg and I share some of our favorite articles, notes, and graphics from the past week along with our commentary. Please feel free to provide feedback and forward along to others if you enjoy. We appreciate you taking the time to read. 

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The Fatal Flaw in Your Retirement Plan’s Target Date Funds

“Economists found that defaulting workers into [target date funds] TDFs increased stock ownership and participation in retirement plans. But TDFs have a major weakness, and their adoption also introduced a new risk to retirees that is just starting to be felt in the current high-inflation environment...

Your goal as you age is not simply capital preservation, it’s replacing lost income. When you reach retirement, you will probably need to finance about 15 to 20 years of spending between you and your spouse. But if you invest in short-term bonds and stocks — TDFs have increased stock exposure for all ages in the last 10 years — you will face a lot of risk because the bonds chosen by TDFs don’t provide much inflation protection (inflation-protected bonds are a tiny part of the bond portfolio). If inflation continues to go up and interest rates rise (decreasing the value of your bond investments), you will fall even further behind.”

It's probably hyperbolic to call it a fatal flaw, but the fixed income allocation in target date funds is a painful flaw at the moment. Most target retirement income funds are approximately 60-70% bonds with moderate interest rate risk and little inflation protection. That allocation has struggled over the past year as interest rates and inflation have surged.

While I don’t necessarily agree with the author’s assertion that inflation-protected longer-term bonds are the answer, there are options to ensure that retirees are properly diversified without losing income potential and purchasing power in their retirement accounts. 

The Weird Contradictions Rendering the U.S. Economy Inexplicable

“Thanks to the pandemic and how advanced economies responded to it, we’re in a very strange place indeed. The typical relationships between one signal from the economy and another have diverged in surprising ways.

• The US is at full employment...and maybe in a recession?
• The Fed is tightening...but financial conditions are easing?
• Consumer confidence is shaky...but they are spending like crazy.
• CEOs are freaking out about inflation...but investors aren’t.
• Gas prices are falling...but inflation isn’t?”

The divergences in economic factors, sentiment, and market conditions have made for a strange year. This article broke down and briefly addressed some of the more contradicting items. The conclusion being that macroeconomic conditions have been whipsawed by the COVID pandemic and response to it. Companies and investors are riding through the continued waves of it, and trying to figure out if this is a “new normal”.

The metaphor that I think captured it well came from Michael Batnick. He compared the current economy and market environment to a Rorschach test. Because of varying data and conditions, pundits, executives, and investors can see what they want to see – good or bad – based on position, industry, political affiliation, and/or past experiences. 

Will 5% Mortgage Rates Cushion the Housing Market?

“After reaching 6.28% on June 14th, 30-year mortgage rates have decreased to 5.05% as of yesterday according to Mortgagenewsdaily.com…

The housing market really started to slow in April and hit the brakes in June when rates jumped to above 6%. Rates around 5% will help at the margin, but it is the increase in monthly payments compared to earlier this year that is impacting the housing market… Currently P&I is up about 30% year-over-year for a fixed amount (this doesn’t take into account the change in house prices). If we include the increase in house prices, payments are up more than 50% year-over-year on the same home.

The bottom-line is the recent decline in mortgage rates will help at the margin, but the housing market will remain under pressure with mortgage rates at 5% (fewer sales, slowing house price growth).”

This covered the state of housing and mortgage rates succinctly. We are seeing some relief with the 30-year down approximately 1% from two months prior, but more than likely, the housing market will continue to cool because of the total cost of carry - higher interest rates and prices even after moderating.

"Today we celebrate the recovery of all the jobs lost in 2020, and the unemployment rate matching the lowest level since 1969.

The headline jobs number in the July employment report was well above expectations, and employment for the previous two months was revised up by 28,000, combined.  The participation rate decreased slightly, and the employment-population ratio increased slightly. The unemployment rate declined to 3.5%."

On Friday, the July jobs report wildly outperformed expectations and also marked the full recovery of jobs lost since the beginning of the Covid pandemic. 

Thanks for reading. Have a great weekend!