Buying U.S. stocks could be a superior way to gain international exposure

Smart investors balance their portfolios between domestic and international financial investments. However, what might not be obvious when selecting stocks is that often investments in domestic companies come with significant international exposure.

“Most investors I speak with unwittingly have way too much international exposure,” says Sam Kendrick, portfolio manager and vice president at Whittier Trust Company. 

Due to globalization over the last 50 years, U.S. companies have been investing more and more overseas, and the amount of international exposure in the S&P 500 has gone up over time. “Around 40% of domestic large cap company revenues come from outside of the U.S. so you’re actually getting a really nice amount of international exposure when you buy the S&P 500,” he says.

Here, Kendrick explains why you get a superior form of—and enough—international investments when buying U.S. stocks.

It’s Less Risky

When you invest in a domestic company that has invested abroad, there’s more oversight at a micro level. “You get U.S. accounting standards, U.S. auditors reviewing the financial statements and the SEC monitoring the buying and selling of the stock,” says Kendrick. “If I just buy Chinese stock in a Chinese company and they said they made $100 million dollars last year, I’m less sure that’s true. Whereas in the U.S., you can be more confident here than elsewhere that they made that money.”

On a larger level, by investing domestically, your investment is being domiciled in a large, stable, democratic country with stocks that trades in dollars, which is the reserve currency of the world. “There is less risk because in times of crisis, investors across the world seek dollar denominated exposure. Because our economy is large and resilient, investors want to own companies with the majority of their revenue generated here rather than from countries that are less stable,” Kendrick says.

It's More Diversified and Less Cyclical

The U.S. stock market is extremely well diversified in a few different ways. For starters, the S&P 500 gets 60% of its revenues from the U.S., 14% from Europe, 7.4% from China and 3% from Japan, according to Factset

“Then from a sector perspective, there are very robust allocations within the S&P 500 to healthcare, technology, communications and industrials. All of these sectors have large, high-quality companies with differentiated products,” says Kendrick. More commoditized sectors, such as energy, materials, financials and real estate, have a relatively low exposure in the S&P 500 compared to foreign markets.

On top of that diversification, Kendrick notes that the S&P 500 is less cyclical than foreign indexes, meaning it encompasses more companies that are less dependent on the economic cycle to grow. According to JP Morgan, 34% of the S&P 500’s exposure is to cyclical sectors, whereas emerging markets’ exposure is 49%, Europe’s is 53% and Japan’s is 57%.

“All else being equal, it’s better to invest in companies that have less volatility in their revenue and earnings growth,” Kendrick says.

It Has the Cheapest Cost of Capital

Kendrick often speaks with investors who are hesitant to allocate more money to domestic stocks because they are more expensive than foreign stocks. However, the other side of the coin is that the expensive price tag reflects a cheaper cost of capital for U.S. companies. 

“Higher valuations mean that U.S. companies can raise money more cheaply. This means large U.S. companies can raise capital and buy foreign assets rather than selling their assets to foreign firms,” says Kendrick. “When it comes to small companies, entrepreneurs, venture capital firms and private equity firms focus on the U.S. because of the higher valuations businesses receive here versus abroad. In turn, having many of the most successful startups based in the U.S. increases our country’s growth rate.” 

He cites Tesla as an example of cheap capital driving U.S. growth. “Despite not being profitable for 17 years, U.S. markets provided the funds it needed to grow. Now it has reached scale and is raising debt and equity in U.S. markets to expand overseas with large factories in Germany and China,” Kendrick says. “It’s hard to imagine the same growth story taking place in another country.” 

When thinking about your portfolio and buying domestic vs. international stocks, consider the above three reasons to buy U.S. over international. Also, consider this: giving up some outperformance in a bull market is ok if the downside protection is better. “Everyone focuses on how U.S. markets have outperformed since the global financial crisis, but the truth is, even if U.S. and international were expected to perform the same, we would still buy U.S. because it’s less risky,” Kendrick says. 

The right kind of insurance can mitigate tax exposure and maximize legacy-building

No matter the length of your balance sheet, preserving the wealth means being smart about how your investments are structured to minimize tax exposure, both in life and as you look to pass wealth on to the next generation.  Some of the best investments for tax efficiency might be a specialized kind of insurance. 

“Private Placement Life Insurance (PPLI) policies have existed for quite some time and have become increasingly popular with wealthy individuals seeking to mitigate tax exposure,” says Whittier Trust Assistant Vice President for Client Advisory Shea O’Gara, J.D. “PPLI policies provide a unique solution for holding tax inefficient investments while maximizing intergenerational transfers of wealth.” Generally, PPLI is most suitable for accredited investors including high net worth individuals, banks, brokers, and trusts. 

PPLI attempts to couple the tax advantages of Variable Universal Life Insurance (VUL) with the growth often associated with alternative investments. This renewed interest in PPLI is largely being driven by wealthy individuals in top tax brackets, with good reason. For instance, in certain circumstances top earners in California and New York can face a combined federal and state income tax rate in excess of 50%. Additionally, assets above the federal estate tax exemption can be subject to a 40% death tax. When structured appropriately, PPLI can mitigate both income and estate tax exposure.

“While a PPLI does offer some estate planning opportunities, the main focus is to capitalize on the tax-free treatment of income and gains produced within the policy,” O’Gara says. Because PPLI incurs no immediate income tax, there is no need to wait for a Schedule K-1 to report the incomes, losses and dividends of a partnership

“PPLI stands in contrast to traditional life insurance policies in many ways, but perhaps most notably it provides an opportunity for the insured to hold non-traditional investment positions,” O’Gara explains. For example, a PPLI policy can consist of private equity, hedge funds, private credit and other alternative investments otherwise not accessible in a traditional life insurance policy. The policy usually contains a high cash balance affixed with a lower death benefit to reduce ownership costs. Although insurance costs vary when owning a PPLI, the long-term tax savings usually greatly exceed the policy cost.

A PPLI operates as an income tax mitigation strategy, but it can also serve as an estate tax strategy if structured properly. Ideally, the policy would be owned outside an individual’s taxable estate through an irrevocable trust. When the PPLI is owned by an irrevocable trust, the death benefit passes estate tax free. If an individual has yet to utilize their lifetime gift exemption, owning a PPLI in an irrevocable trust is a potential option. It can be a smart addition to an overall wealth management strategy, executed by a trusted wealth management advisor. 

Notwithstanding a multitude of advantages associated with a PPLI, there are some drawbacks to consider. Mainly, (1) medical underwriting, (2) lack of control, (3) costs and (4) early surrender consequences. 

  1. The individual insured must be in good health and willing to undergo a comprehensive review of medical records and insurance exam. 
  2. An IRS investor control rule stipulates that the policy holder cannot influence the selection of individual securities held within the policy either directly or indirectly. However, policy owners dictate which funds their policy owns.
  3. Costs vary, but generally PPLI fees include a structuring fee, federal deferred acquisition cost tax, state premium tax, asset-based mortality expense charges, and cost of insurance charges. Initially, PPLI policies are fee intensive and in the short term could exceed the immediate tax benefits. 
  4. Generally, there is no fee associated with surrendering the policy. However, tax may be owed on the appreciation of investments at an ordinary income tax rate.

PPLI is a nuanced solution that can be beneficial to high net worth individuals. PPLI requires a thorough analysis to determine if such a strategy is beneficial due to its complexity.  

How to focus your philanthropic activities for maximum impact

If you’re starting your journey toward philanthropic giving, either because you’re launching something new or because you’ve inherited a role in a family foundation, all of the options for charitable contributions can feel overwhelming. From environmental causes to poverty relief—and everything in between—the options are endless. Rather than trying to help every good cause, it makes sense to hone in on specific areas to maximize your impact. 

“When our clients come to us wanting to start their philanthropic journeys, we help them focus on creating a mission statement,” explains Whittier Trust Client Advisor for Philanthropic Services Amanda Buntmann. “It helps bring everyone together around the same issue area. It’s a key step to figure out what everyone cares about and what's most important to them.” Sometimes that’s easier said than done, since many causes might pull on your heartstrings. Here are some ways to get started. 

Identify Your Highest Values

There are an almost endless array of values most of us aspire to, and the things that we care most about may change and evolve over time. Often, Buntmann and her team will share a deck of cards with more than 75 values—such as innovation, integrity, courage, freedom, dignity and much more—to help clients cultivate their plan. 

Take heart: It’s not uncommon that family members disagree on at least some of the specific focus areas but most can find a few core values that define and motivate them. Once these values are identified, choosing focus areas and grantmaking philosophies becomes easier.  

What Motivates You? 

The National Center for Family Philanthropy put together a helpful Philanthropic Purpose Primer, designed to ask questions that spark ideas for developing a charitable giving focus. Buntmann and her team often talk through some of these questions to help understand what philanthropic causes make clients tick. Some questions are: 

  • What motivates me to be generous? Why do I care? 
  • Who were my role models for generosity when I was young? What did I learn from them? 
  • What life experiences have inspired my philanthropy? 
  • What am I grateful for now? 
  • What is my definition of wealth with responsibility? What is the purpose of our wealth? 
  • Beyond money, are there other resources I have given or could give? 
  • How would I like to be remembered? 

Partner Up 

Trying to identify an area of focus for your charitable contributions alone can feel overwhelming. That’s why hands-on help from a team of experts can be invaluable. When a new client comes to Whittier Trust, the team spends time getting to know them and asking questions about their lives and interests. 

For example, one client, Vanessa, expressed interest in animal welfare. But when Buntmann went to lunch with her and her Whittier client advisor, she asked Vanessa about her favorite pastimes, and her eyes lit up as she talked about her love of reading and her sprawling home library filled with books. Her passion for reading and literacy prompted Buntmann to set up a site visit with a local nonprofit dedicated to building libraries in lower-income communities. “The library wasn't open yet, but local kids were coming to see it. The joy on their faces prompted Vanessa to pursue the goal of funding a library herself,” Buntmann says, which allowed her client to make a meaningful contribution to a community in her home city. While she’s supporting other causes as well, this is the one that pulls on her heartstrings. “Working in private philanthropy services, you have to keep digging and get to know people to understand what they're passionate about,” Buntmann adds. 

Once you’ve identified your values and the causes that motivate your philanthropic endeavors, it’s important to establish procedures and guidelines to streamline the process. The philanthropy services team at Whittier Trust can provide the strategy and support to help you get there. That may involve engaging other departments at Whittier Trust to implement tax efficient investing or other wealth management services to maximize your legacy and reach. Regardless of your goals, you’ll always have a team around you that is wholly committed to helping you achieve them. 

Establishing a family office is a holistic family wealth management solution

Traditional models of wealth management focus solely on the portfolio. This model is flawed, however, as it doesn’t take into account the entire family picture. Seventy percent of family wealth doesn’t transition to the next generation due to a lack of both preparing the wealth for the family and preparing the family for the wealth. 

“Families often don’t have an orderly way to pass on their wealth, but the odds of failure are too large to ignore,” says Lauren Peterson, Senior Vice President, Client Advisor at Whittier Trust in Family Office services. “It is important to ready heirs for the transition to be good stewards of the wealth that is to come.”

Here, Peterson explains the integrated approach that creates sustainable best practices for successful families.

Establish a Family Office or Engage a Multi-Family Office

Establishing a family office is a holistic approach to wealth management and legacy that guides, supports and educates heirs for a more successful wealth-transfer rate. “A professional family office will engage with a family to support investments, values and the next generation,” says Peterson. 

While the older generation can certainly create a single-family office themselves, there is a lot of heavy lifting to do, which might not be appealing at this point in their lives. “Our clients often turn to Whittier Trust for our expertise. We are a multi family office with expert professionals working with similar families who have complex needs who need guidance to meet their goals,” says Peterson, who notes that unlike other firms that might have 100 families per advisor, Whittier has a Client Advisor and support team with unlimited availability for families or less. A team might consist of a Senior Advisor, Junior Advisor, Analyst, Senior Portfolio Advisor and other team members in real estate, philanthropy and more as needed.

Another unique aspect of Whittier’s family office services is that while a Senior Advisor may work with the parents, a Junior Advisor is assigned to younger family members so that everyone can feel comfortable working with someone closer to their age to get support, training and guidance. 

Create a Holistic Governance Structure

Once team members have been selected based on the family’s needs, the family office team then does a deep dive to look at all aspects, from financial documents to family dynamics. “We revise any governance structures, work with their CPA and legal team, look at all their documents and discuss it with the family so that they know what their documents say and mean,” Peterson says. 

Many of the clients Whittier works with have been CEOs or business owners and are used to creating a strategic plan. The goal of the family office is to help clients put together a structure and family strategic plan that lasts multiple generations. “We help them look at their family as a family business including all aspects, such as the legal structures, financial statements, operating companies, and if necessary, different entities. We often review the different agreements for profits split amongst family members,” says Peterson. “We do this to ensure quality communication and transparency among all stakeholders, as this build family continuity.” 

She adds that this process typically involves creating a family constitution that includes the family’s values, who makes the decisions and goals for how the family will interact together now and well into the future. Peterson and her team work to give every family member a voice and family unity, which may include coordinating a family retreat and/or training about the purpose of a family office.

Promote Family Harmony

One of the most important ways to promote family harmony is communication and for everyone to know their roles and responsibilities. “We like to involve the entire family—both bloodline and spouses. The family will tell us how much they want their kids or family members to know, but we make a concerted effort to make unifying decisions,” says Peterson. She notes that this often includes the parents accepting the input of their heirs without giving up their mission and values, as well as spouses being able to weigh in on what they want for their children.

Another popular way families choose to promote harmony is by focusing on philanthropy. “Establishing philanthropic giving goals through a family charitable trust, foundation or donor advised fund can be a way of facilitating good family dynamics and to work together to create a long-term family mission,” Peterson says.

Prioritize Education for Long-term Sustainability

Many heirs have had no direct experience with family finances or in making decisions about their family’s wealth. Therefore, the Whittier team does a lot of work to help prepare children to become good stewards of their family’s wealth. This can go as far as providing a deep dive talent assessment and looking at hard and soft skills to determine the roles that will be a good fit for each individual, in addition to educating them about those roles.

“Education and communication are the two solutions to prepare the next generation,” Peterson says. By establishing a family office and following these best practices, a family can transition wealth successfully and prepare heirs for wealth and maintaining the family legacy. 

“When families come to us, they stay for generations. We’re a long-term relationship company,” Peterson says.

Navigating deferral of gain on QSBS

When you’re growing a legacy, it’s only natural to want to preserve as much of your hard-earned wealth as possible. From exploring the best investment options to the tax efficient funds that suit your overall goals and much more, prudent financial advisors make it a priority to consider any and all options for their clients. For those who own their own businesses, corporate tax structure is of particular interest. 

Case in point: one side-effect of the 2017 Tax Cuts and Jobs Act (TCJA) was the renewed interest in Qualified Small Business Stock (QSBS). “With the corporate tax rate reduced from 35% to 21%, business founders, investors, private equity groups and hedge funds have increasingly turned to QSBS as a way to save millions in taxes,” says Client Advisory and Tax Vice President at Whittier Trust Charles Horn, who looks to maximize wealth retention and growth for his clients. 

QSBS is codified in IRC section 1202 and was originally published in 1993 to encourage investment in emerging companies by providing income tax incentives to holders of such stock. QSBS can only be issued by a C-Corporation with a market cap equal to or less than $50M. The tax exclusion for each issuer of QSBS is the greater of $10M or 10 times the adjusted basis. For a corporation with an adjusted basis of $50M at the time of issuance, the tax exclusion could be as high as $500M. This could be a huge win for a small business owner. 

One important requirement of IRC section 1202 is that the stock must be held for more than five years from date of issuance. The general rule is that the five-year holding period begins when the stock is issued. “We’ve been asked to assist clients where QSBS stock held by a trust has not yet reached the five-year holding period and the underlying C-Corporation is being dissolved. Clients often wonder what if anything can be done in such an instance,” says Horn. “The answer is yes, so long as the stock has been held for at least six months.” This is where IRC section 1045 steps in.

IRC section 1045 allows a taxpayer to defer recognition of gain on the sale of QSBS if replacement stock is purchased within 60 days beginning on the date of sale. “In other words, so long as a taxpayer can identify a replacement QSBS stock within 60 days of the dissolution of the previous QSBS stock, the exclusion can still apply,” Horn explains. 

In fact, IRC section 1045 is more generous than IRC section 1031, which governs like-kind exchanges of real property. Under IRC section 1031, cash received from the sale of real property must be held by a qualified intermediary (“QI”) and cannot touch the hands of the taxpayer for one moment during the transaction. IRC section 1045 has no tracing restriction. “In fact, one could receive the funds from the sale of QSBS, use those funds for some other need, and use replacement funds to purchase new QSBS within 60 days and the rollover remains intact,” says Horn. 

The primary restrictions are that the taxpayer must reinvest the entire sales proceeds (not just gain) in replacement QSBS or gain recognition will be required and the replacement QSBS must meet the qualified trade or business requirement for at least 6 months after the taxpayer’s acquisition. Taxpayers must also make an election of deferral on a timely filed tax return for the year of sale.

In fact, even where newly acquired QSBS later fails the requirements of IRC section 1202 resulting in the recognition of capital gains, the deferral mechanism of IRC section 1045 will still apply. In other words, the deferral of tax under the IRC section 1045 remains intact even if a taxpayer is eventually forced to recognize gain. “IRC 1045 is a powerful tool and safety net for investors looking to take advantage of IRC 1202,” says Horn, who notes that taxpayers should consult their tax attorney or CPA with any questions.

Screen Shot 2022-10-19 at 11.14.22 AM
Pass-Through Scenario

Bringing the philanthropic goals of the past and present generations together 

Many Whittier Trust clients have a family foundation that has been in existence for multiple generations. The foundation may have been set up by great-great-great grandparents who determined its mission and values. Fast forward three or four generations and a lot has changed. The Whittier Philanthropy team’s goal is to provide continuity for the original mission and values while engaging the current generation in the family’s overall giving legacy. The following are a few ways to accomplish this.

Facilitating Clear Communication

It’s not unusual for multigenerational families to encounter differences of opinion on philanthropic choices for their family foundation. Unfortunately, a conversation between generations with differing viewpoints may turn argumentative on its own. This is where Whittier brings value as an outside, neutral party. 

“We often work with all family members on the common goal of making sure all voices are heard and valued and at the same time perpetuating the mission of the foundation,” says Haley Kirk, CAP®, vice president and client advisor for Whittier Trust’s Philanthropic Services, who explains that her team always starts with educating the whole family on the history of the foundation and its mission.

“We can have one-on-one conversations with each family member so that everyone feels that they are given the opportunity to speak freely,” she adds. “We listen to individual opinions and then work them into conversations with other family members.”

In addition to conversations, the Whittier Trust Philanthropic Services team recommends establishing a family website as a good practice for clear communication. The site can feature the history of the family, how they came into wealth, the mission of the foundation and the causes it is supporting.  

Engaging and Aligning Interests with Causes

Parents might be uncertain how to pass their philanthropic interests on to their children and how they can support their kids in finding their own charitable passions that still align with their own. “Because the majority of foundations have the goal of lasting in perpetuity, it is imperative that we involve and prepare the next generation,” Kirk says.  

While philanthropic goals may vary from person to person, Whittier works with parents and their adult or adolescent children to find the common root. For instance, one current hot topic is climate change and a hypothetical example is a family where the parents don’t believe in climate change yet their children feel passionately about helping the environment. “Perhaps because of weather changes, animals are suffering and the family can all agree to help animals, so the grant could be to combat that issue and not specifically focused on climate change,” Kirk says.

Developing a Foundation Associate Board

The development of an associate board when family members reach a designated age is a great way to involve the younger generation in a family foundation. The Whittier team encourages boards to create younger advisory boards that are allotted a small amount of money to give away as a group. “It is an opportunity for them to pick a cause they care about and present it to their family, and gain life skills like public speaking and presenting, research and fact-gathering, and financial evaluation, in addition to supporting something they are passionate about,” says Kirk. 

Preparing to Hand Over the Baton

At some point, it’s time to get adult kids more involved to ensure the continuation of the foundation. This was the case for a Whittier client where the older generation (mom and dad) were running the foundation without their four grown children’s involvement. A strong-willed person, the mother didn’t have faith in the kids to follow what she wanted to do with the foundation. 

“We encouraged the parents to invite their kids to start listening in on board conversations,” Kirk says. Before the first board meeting, however, the parents had a scheduling conflict. “Instead of rescheduling the meeting, we suggested that it move forward and see how the kids would do on their own.”

The result was that the younger generation were very focused on choosing grantees that fit within the foundation’s mission. “It was pretty special.  Seeing that the kids hadn’t spun out in an entirely new direction inspired trust; the parents were able to feel more relaxed about the idea of sharing control with them and one day turning over the reins completely.”  

Sometimes all it takes for families struggling to bring the philanthropic goals of the past and present generations together is some outside guidance and support to get started on the right foot.

What an executive director needs for success behind-the-scenes

Oftentimes families appoint a family member to be the executive director of their foundation. This is perfectly legal and makes sense, as that person can be the voice of the family, promote the mission of the foundation within the community and surface appropriate grantmaking opportunities as part of their job. However, there are several administrative duties that must be performed, some complex, which the family might not know about or in which the executive director might not be well-versed. Additionally, as a foundation grows, there are other considerations.

One example is the story of the English family who came to Whittier Trust after its matriarch had passed away. She had been running the family’s foundation and decided to appoint her granddaughter to the executive director position before her passing. The granddaughter, along with the other family board members, were managing a relatively small foundation of around $3 million. However, upon the grandmother’s death, the majority of her estate was left to the foundation. The foundation now had a much larger annual payout requirement to meet and the family was feeling a bit overwhelmed. They wanted to make sure they were in compliance with all applicable regulatory requirements and wanted to take a more sophisticated approach to the foundation’s investments.

Whittier Trust helped the English family to establish an investment policy statement, diversify their portfolio and align their investments with their values. They also took over several key back-office tasks to set the executive director up for success so that she could continue doing what she does best: representing the foundation in the community and focusing on its philanthropic strategy.

Bookkeeping and Accounting

Keeping the books in order can be a large undertaking. “Whittier Trust takes this off the executive director’s shoulders by preparing quarterly and annual financial statements for the foundation, issuing checks and maintaining the files needed for tax preparation and audit purposes,” says Haley Kirk, CAP, vice president and client advisor for Whittier Trust’s Philanthropic Services.

Preparing Grant Agreements

When an executive director or one of their family members comes across a nonprofit they’d like to support, Whittier Trust can handle the administrative work to review the organization. It was vital for the English family’s executive director to be involved in the community and to support her family’s mission. Instead of being bogged down by back-office work, such as preparing grant agreements, her time is primarily spent meeting with nonprofits learning about what they want to do and their goals. “For example, she’ll send me an email that says she wants to grant $30,000 over 3 years, and ‘Haley, please compile the needed details and grant file to complete the donation,’” says Kirk. “And we get it done.”

From there, Kirk’s team interfaces with the nonprofit to collect the EIN, run a charity check to make sure it can qualify for the grant, get their contact information and create the grant agreement, which may include a grant report requirement. As the date of the report nears, they make a phone call to remind the charity about the report’s deadline. When the next grant is due to the nonprofit, they reach out to the executive director to keep her up to date, as well as send the check. What’s more, Whittier can facilitate multi-year grants and schedule and monitor any subsequent grant reports that the family would like to see.

Tax Preparation

In addition to handling bookkeeping and accounting, Whittier interfaces with the foundation’s CPA to provide any documents needed for tax preparation. 

If a California-based private foundation or charitable trust earns or receives over $2 million annually, it is required to have an audit the following year. “It can be hard to track that number so we keep an eye on the $2 million threshold for our clients,” says Kirk. “If the foundation requires an audit, Whittier then works with the auditors.”

In the case of the English family’s grandmother’s estate, part of the money came in shortly after her passing, then a larger sum arrived. “They might not have realized that they were going over the audit threshold but we could see that on our end. Because the books were clean and up to date, everything was on track for the audit and the executive director and family Board members did not have to worry,” Kirk explains.

Board Meeting Facilitation

Corporate foundations are required by law to have one board meeting every year. “The team at Whittier Trust can stay on top of this so that it doesn’t become a cumbersome process,” Kirk says. This includes all of the logistical planning, such as scheduling the event with multiple parties; preparing the materials, such as proposals, financials and reports for review at the meeting; and taking meeting minutes so the executive director can focus on leading the meeting.

Central Office Funnel

All mail can run through Whittier Trust, which can serve as the central office for a foundation. Using Whittier’s address rather than the family’s reduces the burden on the executive director to triage all that mail. “We can screen out requests that aren’t a fit with the foundation’s mission or guidelines and politely decline them on behalf of the family,” Kirk says.

Initially, the English family was concerned that by giving Whittier the reins to take over the foundation’s administration they would lose some control and not be able to do what they wanted. It ended up being the opposite. Without the burden of administrative tasks, the executive director can now spend more time as the public face of the foundation, which means attending more events and meeting with nonprofits.  Partnering with Whittier Trust has allowed her to thrive and alleviates the worry of liability due to a misstep along the way.

Sep 27th

Our View

The Policy Path Ahead

It is rare to see two consecutive weekly declines of –5% in the stock market. We have unfortunately witnessed this negative outcome in the last two weeks. And sentiment remains bearish through this week as well.

We share some thoughts on the –11% decline in the S&P 500 index since September 12. We focus on 3 events that have catalyzed the most recent decline in stock prices – the August inflation report, the September Fed announcement and the surprise fiscal stimulus from the U.K. government.

The Fed

Markets were initially jolted when CPI inflation data for August surprised to the upside. On September 13, headline inflation came in at 8.3% instead of 8% and core inflation rose by 6.3% instead of 6%. Core inflation also showed a monthly gain of 0.6% instead of the consensus 0.3% expectation.

The higher-than-expected inflation data increased the odds of larger and more frequent rate hikes from the Fed. As much as investors may have geared up for a hawkish Fed, they were still taken aback by the tough Fed policy message on September 21.

The Fed projected that short term rates would rise to 4.4% by the end of 2022 and 4.6% by the end of 2023. And they expect their favored inflation metric to subside to almost 5.5% by year-end 2022, then to around 3% by 2023 and to just above 2% by 2024.

The Fed projections themselves were not too different from market expectations. For example, the market had priced in short rates of around 4.5% next year; the Fed was just a touch higher at 4.6%.

But what may have caught the markets by surprise was the Fed’s ultra-hawkish tone in continuing to fight inflation at any cost. The Fed essentially committed to an additional 150 basis points of rate hikes in the coming months without due regard to “data-dependency”. In the process, the Fed came across as prescriptive and mechanical as opposed to thoughtful and deliberate.

The U.K. Government

The new U.K. government announced a sweeping program of tax cuts and investment incentives on September 23 to boost the country’s faltering economic growth. However, the proposed plan set off several unintended consequences that now pose a greater risk to global markets.

A “loose fiscal, tight monetary” policy has historically led to weaker asset prices. The currency and bond markets in particular reacted violently to the misguided fiscal stimulus in the face of already rampant inflation.

The British pound declined sharply to record lows as investors worried about even higher inflation. The increase in the debt burden also sent long term bond yields to well above 4%.

The combination of the Fed’s hawkish posture and the U.K. fiscal plan sent the dollar soaring by 4%, the 2-year bond yield higher by 30 basis points and the 10-year bond yield climbing by 50 basis points to almost 4%.

The Outlook

The parabolic rise in the dollar and global interest rates create additional risks to the global economy. We assess them in the following framework.

  1. Given the growing evidence of a global slowdown and cooling inflation in the U.S., the Fed may now be approaching a stage of raising rates “too far too fast for too long”. We believe that a rigid and inflexible approach to continued tightening by the Fed may not be optimal.
  2. We advocate an impactful but yet measured and flexible policy path forward. We believe that inflation has peaked and is slowing down meaningfully to afford the Fed enough flexibility in the pace and frequency of future rate hikes.
  3. Our view on inflation peaking and now subsiding is supported by several metrics – copper, lumber, gasoline, house prices, mortgage rates, rents, tax receipts.
  4. Absent a shift in positioning, the risk of a Fed policy misstep is now higher. We believe it will eventually be avoided.
  5. We believe the sharp rise in long term U.S. bond yields is unsustainable especially in the face of declining inflation and demand destruction. Lower bond yields will likely help ease the strain on growth and valuations.
  6. Future rate hikes from the Fed will likely continue to slow growth and increase the magnitude and duration of a potential economic and earnings recession.
  7. The increased odds of a recession are already reflected in the new lows that have been created in the stock market this week.
  8. Unless the Fed blunders into a major mistake, we do not expect a deep and protracted recession or a lengthy bear market.
  9. We continue to hold existing equity exposure, slowly deploy un-invested cash into growth assets in public and private markets and explore ways to create tax alpha from tax loss harvesting.

These are extraordinary times of change, challenge and chaos. We stand ready to help you navigate this unusually high market volatility.

The importance of developing financial literacy and generosity in the next generation

Every family is unique, but virtually all parents hope their children will grow up to be confident, self-sustaining and happy. In short, we hope they’ll be good people and contributing members of society. Families of significant means face unique challenges in this arena, however, because the same wealth that affords them educational, vocational and recreational opportunities has the potential to undermine achievement in their children. 

“Ensuring that a family’s wealth has a positive, rather than negative, impact on kids requires intentionality and thoughtful communication,” says Pegine Grayson, Director of Philanthropic Services at Whittier Trust. “In our 85+ years of working closely with high net worth families, we’ve seen that the key here is to focus on fostering children’s resilience, financial fitness and philanthropic activities and values.” Here are some things to consider. 

Resiliency

Parents’ natural tendency is to want to protect their kids from pain, but too much coddling deprives them of the opportunity to discover their own courage as well as limits. “My mom used to tell me, ‘I can protect you from many things, but one thing I won’t do is save you from the logical consequences of your own actions,’” says Grayson. “I learned important lessons from that philosophy, and also from watching my parents conduct themselves in the community as I grew up.” 

The Whittier Trust Philanthropy Services team encourages clients to model patience and tenacity for their children and to openly share stories about their own failures and how they bounced back from them. Emphasize that the goal is not to avoid mistakes; we’re human and erring is inevitable. Rather, the goal is to own our mistakes, apologize when necessary and take steps to avoid the same ones in the future. Children who learn to treat mistakes and failures as opportunities for improvement will use those skills for the rest of their lives. They’ll learn how to take calculated risks with the confidence that, if they fail, they have the skills and competence to try something new, without expecting others to bail them out. 

Financial Fitness

Members of the Silent and Baby Boomer generations were often taught that talking about money is unseemly, and that orientation can be magnified when it comes to raising their children and grandchildren. Many clients tell us they don’t want to burden their kids with information they may not be ready to understand. 

However, by the time kids are in middle school, they’re usually aware that their family is wealthy. What they lack is the wisdom and perspective to make sense of it. “We encourage clients to begin discussing financial matters in age-appropriate ways once children are old enough to notice disparities between their situation and that of other families,” says Grayson. “This doesn’t mean you should share a detailed balance sheet or even include any numbers. But it’s important to talk about where the family wealth came from, how the family uses it wisely to add value to their lives and how financial decisions about saving, spending and sharing are made.” 

Come up with a strategy to give children age-appropriate ways to practice financial literacy. For example, rather than giving allowances to reward good behavior or as payment for household chores (which should be done just because it’s what family members do), instead use those funds as a tool to teach budgeting skills. 

An Ethos for Giving Back

Help kids make sense of the family’s wealth and become good stewards of what they stand to inherit by being overt about how the family aligns its wealth and values. Talking about what matters most to you and the positive changes you want to see in the world, encouraging your kids to do the same, and then deploying some of the family wealth to promote those changes through charitable giving is incredibly empowering for kids. 

“Many of our clients hope we will help them ‘save their kids from their wealth’,” Grayson notes. “Invariably, we recommend establishing a foundation or donor-advised fund to get kids actively involved in the family’s philanthropic endeavors.”  By participating in the family’s philanthropy, kids develop a spirit of generosity and feel proud of their family’s legacy.  They also learn important life skills such as investment strategies, budgeting, research, humility, respectful listening and communication, and experience the joy that comes from making a positive impact on someone else’s life.” This strategy also helps keep the family united in a common purpose, even as kids grow up and move away.

“Wealthy parents often focus primarily on passing on their assets to their children, which of course is important,” Grayson observes. “In our experience, though, the most successful intergenerational families pay just as much attention to passing on the values and skills that will equip their children to be good stewards of those assets and thriving adults in their own right.” 

The market turmoil in 2022 so far is in sharp contrast to the heady mix of stimulative policy and low volatility in 2021. In 2022, persistently high inflation has led to tighter monetary policy and slower growth.

As a long cycle of easy money draws to an end, we discuss several implications of a more normalized regime of inflation, interest rates, and valuations.

In the short term …

  • Have we just seen that elusive peak in inflation or will the data flatten to deceive?
  • How far behind is the Fed in its tightening cycle and how far does it need to go from here?
  • Are we in a recession now?  If not, when will it arrive and how long will it last?
  • How severe and protracted will the bear market be for stocks and other risky assets?

There are even more intriguing questions on the other side of this economic slowdown.

In the longer run …

  • Where will inflation and interest rates eventually settle?
  • What will stock and bond returns look like?

These are extraordinary times of change, challenge and chaos. We hope these insights help our readers navigate this unusually high market volatility.

empty image