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2023 Mid-Year Review of Stock-Based ETFs

With the first half of 2023 now past, we devote this post to a mid-year review of ETFs in a variety of stock sectors within the S&P 500. As we will see, while this broad market index of large-cap stocks did well, there was significant variation in returns across the sectors of the S&P 500.

Sectors of the S&P 500

There are 11 sectors in the S&P 500 as shown below. While some of these sectors have several ETFs tracking them, we choose the ETFs in parentheses due to their long history in the markets.

  • Information Technology (XLK)
  • Health Care (XLV)
  • Financials (XLF)
  • Consumer Discretionary (XLY)
  • Communication Services (XTL)
  • Industrials (XLI)
  • Consumer Staples (XLP)
  • Energy (XLE)
  • Utilities (XLU)
  • Real Estate (IYR)
  • Materials (XLB)

Using this list and reinvesting dividends, we see that some sectors had total returns that did very well in the first half of 2023, and several did not.

2023 mid-year review of S&P 500 sector ETFs
2023 Mid-year review of S&P 500 sector ETFs. Total Returns. Source: https://www.etfreplay.com/charts.aspx

2023 mid-year sector winners

As the figure shows, the technology and consumer discretionary sectors had the highest total return so far in 2023. In retrospect, the technology sector gains were possibly fueled by sector layoffs that didn’t appear to hurt the investor’s view of the future profitability of this sector. Similarly, future expected consumer discretionary spending gave investors significant confidence in this sector. And, overall, the S&P 500 gained nearly 17% in the first half of 2023. At this rate, the effect of the 3rd year in a presidential cycle on stocks may remain true in 2023.

Losses in the first half of 2023

The energy and utility sectors were the worst-performing sectors of the S&P 500 in the first half of 2023. With increasing interest rates, long-term investments by these sector participants are becoming increasingly expensive. So, it appears that investors don’t see strong prospects for profitability in these sectors.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
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A Presidential Cycle and the Markets

The stock and bond markets are off to a great start for 2023. This news is especially notable after a difficult 2022 for stock-based ETF investors. Including dividends and interest, the iShares Core S&P 500 ETF is up 6.3%, and the iShares Core Total US Bond ETF is up 3.3%. While a strong start can be helpful against losses later in the year, what may be more relevant is that we are now in the third year of a presidential cycle. In this article, we discuss this unusually strong relationship.

Data since 1933

According to a researcher at Charles Schwab using data from 1933 to 2015, the S&P 500 had average returns in the first, 2nd, 3rd, and 4th years of a presidential cycle of 6.7%, 5.8%, 16.3%, and 6.7%, respectively. So, in the third year of the presidential cycle, there was nearly a 10% increase in average returns. We revisited this data to include the end of the Obama administration, as well as the four years of the Trump administration and the first two years of the Biden administration. The results appear in the table below, which indicates that, even with the impact of the global coronavirus pandemic, the relationship still holds.

Presidential YearAverage Return (%)Sample Size
16.724
23.324
313.523
47.523
Average Returns of the S&P 500 from 1928 to 2022. Data Source: www.macrotrends.net

Clearly, we find that correlation is at play here, although the sample size is not very large. But, what could be the cause of this outperformance?

Possible Causes

A 2013 study at the University of Chicago attributed the effect of the 3rd year of a presidential cycle to increased future uncertainty of what a change of administration may cause. Others have argued that in the third year, the current administration has some momentum to start seeing the impact of their policies being implemented. But, it is always important to note that correlation is not causation, and there are likely many other factors at play that are producing this unusual market behavior. By the end of this year, we will see if the 3rd year of the Biden administration continues this outperformance.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
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Inflation and Income Taxes in 2023

Happy 2023! Now is an excellent time to review changes to individual income tax brackets due to inflation. Here, we highlight the relationship between inflation and income taxes. To see details of all the 60 tax provisions changed for 2023, the Internal Revenue Service (IRS) published this document.

How inflation and income taxes are related

As we discussed in our post from last month, the Consumer Price Index (CPI) continues its downward trend. Unfortunately, the CPI of 7.1% for November is still above the long-term norm of 2-3%. However, there is some good news for U.S. income taxpayers in 2023. The IRS adjusts income tax brackets for inflation, so income and capital gains tax brackets in 2023 have increased by about 7%. The images below show these new brackets for income, capital gains, and the standard deduction.

Inflation and 2023 Income Tax Brackets for Single
2023 Income Tax Brackets for Single Filer
Inflation and 2023 Income Tax Brackets for Married Filing Jointly
2023 Income Tax Brackets for Married Filing Jointly
Source: https://taxfoundation.org/2023-tax-brackets

2023 tax rates on retirement income

So, income tax brackets recently changed in a significant way. Our optimal retirement income calculator now provides an updated forecast for after-tax retirement income using the 2023 tax brackets. Forecasts based on the Common Rule withdrawal strategy remain free for 2023. In addition, you can expedite your calculations by registering a free profile. For individuals or financial planners wishing to use our award-winning tool to see the details that led to their individualized tax alpha, please consider subscribing before the price goes up.

Click here to see your individualized tax alpha

Live Software Demonstration

On Saturday, January 14th from 10-11 am Pacific Time (1-2 pm Eastern Time), we will be conducting a live demonstration of our retirement income and retirement savings calculators, fielding your questions, and discussing new features planned for 2023. Please use the link below to join us at this time. If you wish, please contact us prior to this demonstration with any questions you may have or use cases you wish to see.

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Live Software Demo on January 14, 2023, from 10-11 am Pacific (1-2 pm Eastern)

If you are unable to make this live software demonstration, please contact us to arrange for an individual demonstration.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
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Inflation and ETFs

Inflation continues to persist higher than its long-term norm. Very few sectors of the U.S. economy have performed well. In this article, we discuss how ETFs designed with inflation in mind have fared in this current economic environment.

Historical rates of inflation

The U.S. Bureau of Labor Statistics (BLS) is an excellent free source of historical rates of inflation. The image below shows this data for the last 20 years. Clearly, the current inflation rate is above the norm of 2-3%. However, it does appear to be down somewhat from its high in June. Fortunately, we don’t see any recent “grey” area in this chart, which represents the U.S. in a recession, as determined by the National Bureau of Economic Research.

Inflation rates are still elevated above their long-term norm, but off of recent highs from June 2022

ETFs to protect against inflation

We chose three ETFs to show that not all ETFs are created equal in addressing inflation. Here, the acronym “TIPS” stands for “Treasury Inflation-Protected Securities”.

  • iShares Barclays TIPS ETF (ticker: TIP), $25B in assets
  • SPDR Bloomberg Barclays 1-10 Year TIPS ETF (ticker: TIPX), $1.4B in assets
  • Vanguard Short-term 0-5 year Inflation Protected ETF (ticker: VTIP), $17B in assets

    The most significant difference in these three ETFs is the term to maturity of the bonds contained within them. This difference has led to very different total returns for these three ETFs in 2022, as shown below.

    2022 Year-to-Date Total Return of Three ETFs offering inflation protection

    So, what’s going on?

    As one of my favorite writers at the Wall Street Journal recently wrote about, rising short-term interest rates are having greater impacts on the price of longer-dated bonds. This impact includes treasuries with inflation protection which each of these ETFs contains. The weighted average maturities for these three ETFs are 7.4 years, 4.7 years, and 2.5 years. By comparison, the broad-based iShares Core U.S. Aggregate Bond ETF has a weighted average maturity of 8.7 years and is down about 11% in 2022. So here, we see the limitation of a fund, like an ETF, that maintains a steady average maturity. Rising interest rates are offsetting the inflation benefit. Unfortunately, investors can avoid this with a bond ladder, but doing so requires investors to leave the relative ease of investing in ETFs.

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    ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
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    Asset Correlations in 2022

    In 2022, many long-term trends in asset correlation appear to be changing. In this post, we discuss the longer-term trends in several popular asset class correlations and highlight recent changes that continued from the first half of the year.

    Short-Term Correlations and Long-Term Trends

    The stock and bond markets continued their downward slide this month. The iShares Core S&P 500 losses for 2022 reached 24%. In addition, the bond markets continue their losses for the year, with the iShares Core U.S. Aggregate Bond Market ETF down about 15%. This latter result is quite surprising, given the long-term correlation between the stock and bond market is 5%, but has recently grown to over 40%. Thus, the stock and bond market returns are more similar than they were in the past, so provide fewer diversification benefits. The chart below shows this upward trend in the correlation between the stock and bond markets in blue. The horizontal dotted line shows the long-term correlation from returns dating back to February 2004.

    90-Day Asset Correlation of Total Returns against the S&P 500 Index
    90-Day Asset Correlation of Total Returns against the S&P 500 Index

    Asset Correlation Among Other Sources

    The chart above also highlights the diminished effect of other sources on a portfolio’s diversification. For example, international equities are often sought for their diversification benefit. However, the long-term correlation of 88%, which also appears in this figures legend, hasn’t changed much this year. Bitcoin’s long-term correlation is 21%, but this correlation has steadily grown to over 60% this year. The one asset that has performed well this year is a direct investment in the U.S. Dollar ETF, ticker UUP. Long-term, the dollar has an insignificant correlation to the S&P 500. However, in 2022, the dollar’s correlation to the S&P 500 has grown significantly negative, as interest rate rises have increased demand for U.S. dollars. The chart below shows the total return of the five ETFs discussed here.

    2022 year to date returns of a variety of assets classes
    2022 Total Returns for ETFs associated with the S&P 500, Bonds, International, Bitcoin, and U.S. Dollars.

    Given the economic pressures creating these effects on the markets, the remainder of 2022 may continue to surprise investors. In particular, asset classes that formerly had low correlations to the stock market may continue to diverge from their long-term values.

    ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
    ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
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    Mid-year review of stock-based ETFs

    With the 1st half of 2022 now behind us, we devote this post to a mid-year review of ETFs in a variety of stock sectors. We also highlight some recent research on sectors that have historically held up well during periods of high inflation, and the benefit of time horizon when investing in stocks. We hope you find this mid-year review helpful!

    Record-breaking 1st half of 2022

    According to this MarketWatch article, the S&P 500 recorded its steepest 1st-half year loss in over 50 years. But, remember that the S&P 500 is a broad-based index consisting of many different companies across a variety of industries. In fact, there are 11 sectors in the S&P 500, which in order of size (and an ETF to represent them) are:

    • Information Technology (XLK)
    • Health Care (XLV)
    • Financials (XLF)
    • Consumer Discretionary (XLY)
    • Communication Services (XTL)
    • Industrials (XLI)
    • Consumer Staples (XLP)
    • Energy (XLE)
    • Utilities (XLU)
    • Real Estate (IYR)
    • Materials (XLB)

    Mid-year review of best and worst performing sector ETFs

    The chart below sorts the total return for the 11 ETFs identified above for 2022. As can be seen here, the biggest gains were among the energy sector (XLE) and the worst in consumer discretionary (XLY). Over this same period, the S&P 500 total return, measured by the iShares Core S&P 500 ETF (ticker: IVV) was -19.2%. Also, note that the energy sector was the only ETF here that saw a positive return, which is not surprising given the war in Ukraine and its impact on supply in the energy sector.

    Mid-year review of returns from 11 sector-ETFs in the S&P 500 Index
    Mid-year review of returns from 11 sector-ETFs in the S&P 500 Index

    Where will stocks go from here and what to do about it?

    Given the current high inflation rates, Derek Horstmeyer at George Mason University recently showed the following “inflation fighters” in his June 5th Wall Street Journal Article.

    Best performing sectors during periods of high inflation. Source: Derek Horstmeyer
    Best performing sectors during periods of high inflation. Source: Derek Horstmeyer

    Of course, the most prudent course of action may be to simply do nothing based on this mid-year review. Given longer investment horizons, the stock market is less likely to suffer losses. Based on Bank of America research, the chart below supports this fact.

    But, as this article notes, behavioral economists know that the pain of loss is greater than the pleasure of gains. So, the 2nd half of this year remains quite uncertain, as market volatility remains elevated.

    ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
    ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
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    Inflation Hedging

    Inflation hedging continues to be of great interest for investors large and small. In this post, we quantify some possible ways to combat inflation based on a recent article in the WSJ.

    Historical Inflation Trend

    Inflation is currently around 6%, well above the 2% rate seen recently. The chart below shows how most of this change occurred in 2021. This rate is well above the 2% long-term target set by the Federal Reserve. So, what are some options for investors in this current inflation climate?

    Inflation is about 6% in late 2021

    Treasury inflation-Protected Securities (TIPS)

    TIPS are one of the most obvious places investors look for inflation hedging. The iShares TIPS Bond ETF (ticker: TIP), with over $30 billion in assets, is a popular option. This ETF has performed notably better than a broad bond benchmark, like the iShares Core U.S. Aggregate Bond ETF (ticker: AGG), as the chart below illustrates. Note that while TIP has slightly higher volatility than AGG, it performance in 2021 is noticably better. In fact, according to ETFReplay.com, the 2021 year-to-date return of TIP is 5.4%, versus -1.0% for AGG.

    Commodities

    There are certainly other options investors can consider. For example, investors often seek commodity investments when inflation rises. This recent study by Vanguard indicated that a 1% rise in inflation could produce a 7-9% rise in commodities. This estimate looks surprisingly accurate, as the ETF DBC (PowerShares DB Commodity Index) should be up 28-36% in 2021, given the inflation rate increase this year from 2% to 6%. In fact, DBC is up 32.7% in 2021, according to ETFReplay.com

    Updated optimal portfolios

    For subscribers of our ETF optimal portfolios, we encourage you to log in to see the latest updates. Note that, based on our latest backtesting, monthly portfolios change more quickly now to respond to market dynamics.

    ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
    ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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    Inflation and Tax Brackets

    Inflation has been in the news quite a bit lately, as the CPI (Consumer Price Index) has shown a year-over-year increase of over 5% since June of 2021. Higher inflation means a loss of buying power. Fortunately, the U.S. tax system does take inflation into account when tax brackets are updated each year. In this post, we discuss the implications of updated tax brackets for 2022 due to inflation.

    quote board on top of cash bills
    Photo by Karolina Grabowska on Pexels.com
    Note:  This post has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

    Income Tax

    Income tax brackets determine what tax rates apply to each additional dollar of taxable income. These rates are especially important for retirees. Below are the 2021 and 2022 tax brackets. As you can see, the Internal Revenue Service has increased the income limits up for all rates and for all types of tax filers. Thus, if your taxable income did not change from 2021 to 2022, your after-tax income will likely increase.

    2021 Income Tax Brackets
    2022 Income Tax Brackets

    Capital Gains Tax and Standard Deductions

    Capital gains taxes, as well as the standard deduction, also have increased from 2021 to 2022 tax years. The increase in standard deductions is $400 for single filers and $800 for married individuals filing a joint tax return. These higher deductions mean that, all else being equal, a taxpayer will likely have lower taxable income, and higher after-tax income and gains. Also, higher income limits for capital gains mean that qualified dividends and long-term realized capital gains on most investments should produce fewer capital gains taxes.

    Other Changes

    While there are quite a few other changes to taxes in 2022, there is no change to the contribution to Individual Retirement Accounts. But, for those with access to workplace retirement plans, like 401(k)s, 403(b)s, and 457 plans, individuals can contribute $20,500 in 2022, an increase of $1,000 from 2021. While such a decision will defer taxes and should lead to higher account values in the future, anyone concerned about future tax increases may wish to consider contributing to Roth 401(k)s and Roth 403(b)s if their workplace makes them available. You may also wish to use our free online calculator to forecast your taxable and retirement assets in retirement.

    ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
    ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

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    Backtesting for 2021 and ETFMathGuy portfolio enhancements

    Due to portfolio performance not meeting our recent expectations, we revisited our backtesting results from August 2018 and produced important new insights and portfolio construction enhancements. We discovered that a longer sample period, identified previously, no longer applied. The image below shows that a three-month sample period produced the best returns from January 2020 to August 27, 2021. Each point on this line plot represents annualized backtested performance for 19 monthly portfolios over this testing period.

    Backtesting for 2021 to find the optimal sample period (months) for ETFMathGuy Portfolio Construction
    Backtesting for 2021 to find the optimal sample period (months) for ETFMathGuy Portfolio Construction

    What performance predictions occurred with this shorter sample period?

    Using this shorter sample period, we produced the plot below of total return since January of 2020. We chose this time period to include the full pre and post-term effects of the coronavirus on the world economy. In addition, and based on subscriber feedback, we now exclude ETFs that issue K-1 tax forms to investors. We made this decision because these 22 ETFs had a marginal effect on backtested performance that used over 1,000 other ETFs that do not issue K-1s. We also increased our ETF filter threshold of median volume to improve liquidity for future portfolios that will likely have a higher turnover rate. The consequences of these decisions on backtested performance appear below.

    Backtested Returns from 2020-2021 of the ETFMathGuy Optimal Portfolios
    Backtested Returns from 2020-2021 of the ETFMathGuy Optimal Portfolios

    Future ETFMathGuy portfolios

    Given the improvement potential identified from this updated backtesting for 2021, all portfolios published in September 2021 and later will follow these updated findings. This update for the September portfolios will likely indicate a significant change from the August portfolios. However, future monthly portfolios will change less significantly. So, we encourage subscribers to log in and see the September ETFMathGuy portfolios that are based on this evidence-based analysis.

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    ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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    Measuring cryptocurrency risk

    Cryptocurrency risk is well known to be very high for many reasons. However, both individual and institutional investors continue to evaluate it as part of their investment portfolios. This post discusses recent cryptocurrency trends in a diversified portfolio and how the risks of this alternative investment compare to mainstream investments like stocks and bonds.

    Volatility estimates

    Volatility is one common way of assessing the risk of any investment. For the stock market, we provide a historical perspective, updated daily, to see how volatility changes over time for the stock market. But, how does this volatility compare to investments in cryptocurrency? The chart below shows a 3-month annualized volatility for the last several years of the stock market, measured with the ETF IVV, the bond market, measured by the ETF AGG, and the crypto market, measured by the Grayscale Bitcoin Trust  (GBTC). As this chart shows, bond volatility is the lowest, averaging between 3-4%. Stock volatility is higher, averaging between 15 – 20%. Cryptocurrency risk is about five times higher than stocks, with average volatility between 90-100%.

    3-Month Annualized Volatility of the stock, bond, and cryptocurrency markets. Source: ETFMathGuy.com
    3-Month annualized volatility of the stock, bond, and cryptocurrency markets. Source: ETFMathGuy.com

    How much to allocate to cryptocurrency?

    This recent WSJ article provided some guidance for individual investors interested in investing in cryptocurrency. While the answers to this question really depend on the individual’s risk tolerance, this article suggested between 1-2%. So, even if the value of the crypto investment hits $0, the investor limits their loss to this original investment amount. But, given the high levels of volatility, more frequent rebalancing may be prudent. Thus, if there is a substantial increase in the price of a crypto investment, the targeted 1-2% allocation would most likely require selling some of the crypto gains.

    Unfortunately, selling short-term gains can be “expensive”, especially for those individual investors in a higher income tax bracket. In this case, the use of a Roth IRA may be the best approach. Why? An investor can realize Roth IRA gains tax-free if taken after age 59 1/2 from an account open for more than five years.

    ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
    ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.