Stock Market Pain, Top Consumers, Long-Term Stocks, Workers and AI, Bank Scam, Cannabis Sales, Student Loan Tax, Hedge Funds & AI-Assisted Homework Cheating

Is there more pain coming for the stock market?

Both the NASDAQ and the S&P 500 have now hit correction territory and people are hoping that the worst is behind us. I would tell people to be prepared for more pain. The tariffs are still a big concern and the uncertainty around them has not cleared.

Also, even with the pullback valuations for stocks are still high. We base our concerns on the fact that many valuation ratios are elevated compared to historical levels, but one that really stands out is the CAPE ratio, which stands for cyclically adjusted price-to-earnings. This was developed by professor Robert Shiller many years ago and the ratio uses a 10-year average of inflation adjusted earnings to value stocks.

In January, it was at 37.74, which was the third highest level in the past 100 years. Not only was it the third highest level, but it was higher than what it was in 1929. After the ratio hit these high levels in the past, stocks declined dramatically. I believe with the headwinds ahead, we could be in for some stormy waters over the next 3 to 6 months.

How much more do top consumers spend?

When looking at consumer spending it is obvious that is not a constant level straight across the board and people making more money would obviously be spending more money in the economy. But just how much more is the high-end consumer spending than the average consumer? The top 10% of consumers account for 49.7% of consumer spending. If you’re thinking that sounds high, you are correct. You would have to go back to 1989 to match that type of imbalance for consumer spending. Is it a bad thing? Not really. The high-end consumer is what is keeping the economy going overall as it creates jobs and allows for the continued movement of money. 

Holding stocks long-term doesn’t always pay off

You probably have heard that you should hold stocks for the long-term and you’ll be fine. I generally I agree with this statement, but there are always exceptions to the rule and that holds true here. If you look at different 10-year holding periods, you will see more losing periods than you probably expected. As an example, the 10-year period ending February 2009 had a loss of 37.4%.

There are other 10-year holding periods such as the ones ending September 1974, August 1939, June 1921, October 1857 and April 1842 that all had losses ranging from 23 to 37.3 percent. Those losses are in real terms adjusted for inflation. One reason these periods had great losses is they were generally periods when there was high speculation that then caused prices to rise to elevated levels just to see them fall back to reality. This is why it is important for investors to not just buy into a story of a stock, but to understand what they are paying for the earnings, sales, book value, and cash flow of the business. If you don’t keep your eye on these valuation ratios, you would not realize when the stock becomes overpriced and you could end up with a big loss and then be left wondering what happened.

I’ve been managing money for over 40 years and have continued to keep my eye on the ball as far as what we pay for any investment whether it is stock, real estate or bonds. If you invest blindly just based on the stock going up and the hype around the story, you could end up with a period of 10 years where you made no gains and then think stocks are risky or a bad investment. In a situation like that, it is similar to driving down the street with a bag over your head not seeing what is around you.

What is Form 5498?

When funds are distributed from a retirement account, a 1099-r is generated and used to file your taxes to report what kind of distribution it was. This is true whether the distribution is taxable or not. For example, if you rolled money from a 401(k) to an IRA, it is a non-taxable rollover, but a 1099-r is still created since funds left the 401(k) which needs to be reported.

A Form 5498 is generated when funds are received by any type of IRA for any reason. So, if you made contributions, conversions, or recharacterizations with a traditional, Roth, SEP, or Simple IRA, you will receive a 5498 stating what happened. Depending on what you did, you will likely need to report the activity on your taxes. The problem is, in many cases the Form 5498 is not ready until May of the following year, even though taxes are due the previous month, on April 15th. Here are some examples where this can create problems. If you did an indirect rollover where you withdrew retirement funds and replaced them within 60 days, the withdrawal should not be taxable.

However, if only the 1099-r from the distribution is reported because there is no 5498 that shows money was replaced, it may be reported as a taxable distribution rather than a rollover. If you are doing backdoor Roth contributions, a 1099-r is generated when the funds are converted from the traditional IRA to the Roth. If it is not also reported that a non-deductible contribution was first made to the traditional IRA, the conversion may be treated as a taxable conversion. Lastly, if you have been making deductible traditional IRA contributions, but there is no 5498 showing the contributions, you may not receive the tax deduction. I don’t know why this form comes later than other tax forms, but this is necessary to be aware of to correctly report tax information and avoid unnecessary tax. 

Workers have fear of AI

Artificial intelligence is here to stay and we know that it will replace some jobs. The jobs most likely to be replaced are data entry clerks, bookkeepers, customer service representatives, proofreaders, and market research analysts just to name a few. The percentage of US workers that worry about losing their job in the future to artificial intelligence has now hit 52%.

We are seeing artificial intelligence more widely used in business and that’s probably why 16% of workers say that artificial intelligence is already starting to replace workers today. Be sure that you have a job that is enhanced by artificial intelligence, not replaced by it because of the repetition of the job or the lack of emotional need in the job that you are doing. I do believe things are changing quickly and that by the year 2030, the job market will look quite a bit different.

Watch out for a new tricky bank scam!

Advancement in technology is great, but unfortunately it also has made scams look more realistic. The latest one is you receive a phone call and on your phone identification, it shows the name of your bank with the words bank branch behind it. As an example, it could say Bank of America bank branch. Your guard is down because the ID uses your bank name and they are calling to verify charges on your credit card, which banks have been known to do. They then list off a couple of charges and ask if you made those charges and obviously you say they’re not yours. Then they say OK let me cancel your credit card and we will send you a new one which also sounds normal as they have not asked for any account numbers or personal information. Then they tell you it looks like your other cards could’ve been hit as well.

Have you received any other calls from any other banks? They then tell you let me cancel those credit cards for you and you should call your other banks to check to see if they’ve been compromised as well just to be safe. So far it sounds legitimate. Then they tell you I can’t cancel your credit card because you have a red mark and you need to call TransUnion to get that corrected. You are then told they can either transfer you to that number or they can give you the number to call them. This is where you’re caught because they’re not transferring you to TransUnion or giving you the correct number for TransUnion but instead, they are connecting you to a company that will ask for your information like your Social Security and perhaps other information on your credit cards.

Unfortunately, they have now tricked you into giving them information that you feel comfortable with because you believe you are talking to the credit bureau that you called. Be very careful if you get a call from your bank telling you that there are false charges on your credit card and here is how we can fix it. What you need to do is hang up the phone and call your bank directly to verify that you have these bad charges. 

The boom to bust for cannabis sales

It was about eight years ago when there was all this hype about getting into legalized cannabis and how people were going to make all this money. One of the first places to legalize cannabis was Pueblo County, Colorado. In the beginning all was great and even the counties were excited as in 2021 they collected over $7.1 million in tax revenue. However, today that has been cut in half.

Nationwide it is estimated roughly only 27% of legal cannabis businesses are profitable, down from 42% in 2022. The profit margins are shrinking and expenses are rising. The number of cannabis growers throwing in the towel continues to rise and some are even filing bankruptcy. The whole idea that legalizing marijuana would lead to a boom never made sense to me because it’s so easy to grow and according to market research company Whitney Economics, black market dealers still account for about 70% of the market in the US. Some things just don’t change and I doubt the market for legalized cannabis will improve anytime soon going forward, which means holding any cannabis stocks probably will lead to poor performance in the years to come.

You may owe tax on a student loan that was forgiven

We recently wrote about how people are getting negative credit surprises because they did not know that their student loan forgiveness had expired. By not making the reinstated payments, their credit score dropped dramatically. There are some people who did receive forgiveness on their student loan, but if you live in California or 13 other states and you use the Income Driven Repayment Plan, also known as IDR forgiveness, these forgiven loans are not tax-free.

The federal government allows you not to pay tax on your forgiven student loan, but you must include IRS form 982 for the year you receive the 1099 – C form for the cancellation of debt. If you don’t do that, the IRS will assume you owe tax on the forgiveness. Keep in mind both for state and federal taxes if you don’t pay on time, you’ll then be hit with interest and penalties on top of the tax that you didn’t know you owed.

Hedge funds are contributing to the recent volatility

Multimanager hedge funds account for about 9% of industry assets based on data from 2023 and according to Goldman Sachs they account for about 30% of the hedge fund industry stock market footprint. Some things have changed in the hedge fund industry with the concept of multi manager firms employing hundreds of semi-autonomous investment teams to trade all kinds of securities and derivatives.

There’s a lot of pressure to perform at hedge funds in the short term and at some firms if your portfolio loses 5%, the main manager will cut that manager’s allocation by as much as 50%. If the loss for a month hit 7 1/2%, it could force that manager to sell all the trades as they would be fired by the firm. With this type of pressure and short term expected results, it can cause a lot of volatility in the markets, especially in your popular companies like the Mag Seven. Many of these hedge funds invest in similar stocks, so when one starts selling, the others generally have to follow along to prevent any more losses in their portfolio.

I’m not a big fan of hedge funds as they charge excessively high fees and take a higher risk on their investments by using leverage and derivatives. Because of the continued pressure they could have great returns for many years and then just one bad year with a huge loss could cause them to close the fund. It could then turn up years later with a different fund name in hopes that investors forget the troubles the hedge fund manager had in the past. If you like excitement, maybe the hedge funds are something you may like, but I still believe you’re better off in the long-term investing in good quality equities at good prices and holding them for the long run. That’s what the most famous investor of all-time, Warren Buffett, has done and he has outperformed many hedge funds over many years.

Are kids cheating on their homework with AI?

It is unfortunate, but kids in high school and college are using services like ChatGPT to do their homework and write essays. It is estimated that of the 400 million people that use ChatGPT every week, a big portion is students. Open AI is probably very happy about this because it is likely the students will depend on AI for their lifetimes. Of students who admit to using AI in middle school and high school, roughly 40% of them said they use it without permission from the school or the teacher.

College students were even worse with nearly 50% saying they are using it without permission from their professors or the college. The big area of abuse appears to be students using it to write essays. The problem here is the students are losing the capability of putting their thoughts onto paper by having it done for them. There are AI tools that can help teachers detect ChatGPT generated writing, but it has been declined to be released because that would probably hurt the business of students paying for and using AI to write essays and do their homework. I have mixed feelings about this because when the students get into the workforce, they will have to think for themselves, but then again, maybe it will be a valuable tool for them to know how to use AI in the workforce to become more productive.