News
Sunday
Jul152018

Second Quarter 2018 YDFS Market Review

I often remind my clients and prospects that judging market performance for periods shorter than a few years, isn’t very helpful. Market returns are simply random over relatively brief periods. However, over longer periods, such as five years, stocks are almost always profitable and offer very good performance. The S&P 500 has finished higher in 91% of the rolling-five-year periods over the last 50 years.

Nonetheless, it's helpful to check back and see how well the markets performed over the past quarter  While the U.S. equity markets suffered a small setback in the first quarter of 2018, the second quarter brought us back into positive territory.

The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—finished the quarter up 3.83%, and is now in positive territory for the first half of the year, at +3.04%. The comparable Russell 3000 index is up 3.22% so far this year.

Large cap stocks more than recovered their earlier losses. The Wilshire U.S. Large Cap index gained 3.41% over the past three months, to finish up 2.62% for the first half of the year, while the Russell 1000 large-cap index stands at a 2.85% gain at the year’s halfway point. The widely-quoted S&P 500 index of large company stocks gained 2.93% in value during the year’s second quarter, rallying to a 1.67% gain so far in 2018.

Meanwhile, the Russell Midcap Index is up 2.35% in the first six months of the year.

As measured by the Wilshire U.S. Small-Cap index, investors in smaller companies posted a 7.87% gain over the second three months of the year, and now stand up 7.08% at the half-year mark. The comparable Russell 2000 Small-Cap Index is up 7.66% for the year. The technology-heavy Nasdaq Composite Index finished the quarter with a gain of 6.31%, and is now up 8.79% at the halfway point of 2018. Much of the over-performance of the NASDAQ can be attributed to a handful of stocks such as Amazon, Facebook, Google and Neflix.

International stocks are not faring quite so well. The broad-based MSCI EAFE index of companies in developed foreign economies lost 2.34% in the recent quarter, and is now down 4.49% for the year. In aggregate, European stocks were down 2.74% over the last three months, posting an overall loss of 5.23% for the year, while MSCI’s EAFE’s Far East Index lost 3.24% in the second quarter, down 3.33% so far in 2018. Emerging market stocks of less developed countries, as represented by the MSCI EAFE EM index, went into negative territory for the quarter, down 8.66%, for a loss of 7.68% for the year.

Looking over the other investment categories, real estate, as measured by the Wilshire U.S. REIT index, gained 9.73% during the year’s second quarter, and is just eking out a 1.52% gain for the year. The S&P GSCI index, which measures commodities returns, gained 8.00% in the second quarter, up 10.36% for the year, mainly due to the rising price of oil.

In the bond markets, coupon rates on 10-year Treasury bonds have continued an incremental rise to 2.86%, while 30-year government bond yields have risen slightly to 2.99%. Five-year municipal bonds are yielding, on average, 2.00% a year, while 30-year munis are yielding 3.00% on average. Simply put, at present, investing in bonds with a term greater than 10 years is not rewarding you for the many years of interest rate risk you're taking. That may change.

So what’s going on? There appear to be several forces fighting for control over the investment markets. The current bull market started in March of 2009, and seemed to be running out of steam in the first quarter, before a sugar high—the stimulus provided by the recent tax bill—kicked in for companies that have traditionally experienced higher tax rates. This pushed a tired bull market forward for another quarter, and could do the same for the remainder of the year. A fiscal stimulus in the ninth year of an economic expansion is almost unheard of, but it is clearly having a positive effect: economic activity was up nearly 5% in the second quarter, unemployment has continued a downward trend that really started at the beginning of the bull market, and corporate earnings—with the lower corporate taxes factored in—are projected to increase roughly 25% over last year.

The other contestants for control of the economy seem destined to lose this year and possibly start winning in 2019. The Federal Reserve Board has raised short-term interest rates once again, and has announced plans to continue in September, December, next March and next June. Bonds' share of investors' dollars at some point will overtake stocks as government 10 year bond yields reach 4% or more, making it difficult for stocks to levitate at current levels.

Meanwhile, the labor markets are so tight that there are more jobs available than workers to fill them. Won’t this eventually force companies to share their profits in the form of higher salaries? And there are potential problems with the escalating trade war that America has picked with its trading partners that will almost certainly not have a positive impact in the long term.

Bigger picture, the flattening yield curve—where longer-term bonds are closer to yielding what shorter-term instruments are paying—is never regarded as a good sign for an economy’s near-term future. It’s worth noting that the financial sector—that is, lending institutions—was one of the economic sectors to experience a loss. Banks borrow short and lend long, and there isn’t much profit in that activity when the rates are about equal.

Beyond that, in a good year, corporate earnings would grow around 5%, so one could argue that the economy is now experiencing five years of earnings growth. Add these factors to the doddering age of the current bull market, and you have to wonder how long the party can continue. Nobody knows what tomorrow will bring, but everybody knows that bull (up-trending) markets don’t last forever. This may be a good time to mentally and financially prepare for an end to the long bull run, and to hope it ends gracefully. For our clients, we remain cautious bulls and are keeping our hedges in place. The higher volatility we've experienced so far this year shows no sign of waning, and the low-volume summer trading season is the ideal time for market shenanigans to show up.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

Wilshire index data: http://www.wilshire.com/Indexes/calculator/

Russell index data: http://www.ftse.com/products/indices/russell-us

S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf--p-us-l--

Nasdaq index data: http://quotes.morningstar.com/indexquote/quote.html?t=COMP

http://www.nasdaq.com/markets/indices/nasdaq-total-returns.aspx

International indices: https://www.msci.com/end-of-day-data-search

Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci

Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Bond rates: http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/

General: https://www.marketwatch.com/story/stocks-see-broad-gains-in-the-second-quarter-but-not-without-turbulence-2018-06-29
https://www.cnbc.com/2018/06/08/gdp-for-second-quarter-on-track-to-double-2018-full-year-pace-of-2017.html

https://finance.yahoo.com/news/jobs-report-4th-july-need-know-week-ahead-191630507.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Monday
Jun252018

Social Insecurity & Medicare Insolvency?

With about 10,000 baby boomers on average retiring every day, it's not unusual for me to talk to clients and prospects who are anxious about the future of social security and medicare. Some clients, despite evidence and advice to the contrary, have gone ahead and filed for social security benefits even if it meant they would potentially reap hundreds of thousands of dollars less over their lifetimes, because they are worried that the systems are going "bankrupt".

Given the stories and rumors that seem to float around endlessly about the imminent demise of social security and medicare, it is understandable that many were alarmed when, on June 5, the good people who run Medicare and Social Security released a report that said that the Medicare program will become insolvent in 2026 and Social Security will face a similar fate in 2034. The Medicare projection is three years earlier than the previous report, while the Social Security projection is unchanged from previous estimates.

These problems are not new, of course. People are living far longer than anticipated when Social Security was created in 1935; in fact, the average life expectancy for a person who managed to reach age 30 at that time was age 68 for men and 70 for women. Today it’s 79 for men and 82 for women. Meanwhile, Medicare has been hit with higher-than-inflation increased medical expenses—along with, of course, those longer lifespans.

Alarmists point out that the Social Security and Medicare Trust Fund reserves are “invested” in government securities, which is essentially the government writing itself an IOU—currently to the tune of $2.8 trillion, which is the total “asset reserves” in our largest social programs. Individuals are advised not to run their own finances this way, accumulating deficits but meticulously keeping slips of paper around which represent a promise to pay back every single nickel and dime eventually. But in fact, today nearly all of the money paid out to Social Security recipients, and on behalf of Medicare enrollees, are simply transfers of money paid into the program by current workers. The money comes in as FICA payments and taxes on Social Security benefits, and goes right back out the door to beneficiaries. We've all heard the expression that "our government is running the world's largest Ponzi scheme".

So where’s this alleged deficit? That can be found on page 9 of the report, in a section labeled “Assumptions About the Future.” There, the report makes economic projections about the next 75 years, including the future fertility rate (children per woman), mortality, the annual percentage change in worker productivity, average annual wage increases, inflation, unemployment and the interest rate earned by those IOUs the government is writing to itself. Page 18 shows a graph that illustrates the projected outcomes of three different sets of assumptions for all these (basically unknowable) variables, and one can see that two of them are, shall we say, not optimal, while the third projects not just solvency, but actual prosperity for the combined trust funds going forward well past the year 2090.

Social Security Solvency 2

Even if the worst case comes to pass, and the programs goes “bust,” they won’t actually stop paying benefits. There will still be workers who pay in FICA taxes, and even if there is no trust fund, these collected payroll taxes can be transferred, as they are now, to Social Security and Medicare recipients. The Social Security trustees report, on page 58, how much of the projected payments would be covered by workers going out to 2090 under the three future scenarios. The worst case scenario says that there will be roughly an 18% shortfall in 2040, rising to roughly 22% by 2090. Basically, that means that Social Security recipients, worst case scenario, would have to get by on 82% of the benefits they were expecting in 2040, and 78% if they manage to live all the way out to 2090.

And, of course, that’s if nothing is done to shore up the program between now and then. One of the simplest options on the table is to raise the age people can collect full retirement benefits as the average lifespan goes up, basically “indexing” retirement benefits to changes in longevity. Congress could also marginally raise FICA taxes (e.g., the taxable wage limit) or impose more taxes on Social Security income. Minor tweaks to the system can add decades to the solvency of social security and medicare.

The best advice here is not to panic about the fate of our country’s social programs. There is no question we need to address their solvency, and with gridlock in Washington, that seems like a bit of a long shot. But even if Congress can’t agree on tweaks and fixes, the world won’t come to an end. Social Security and Medicare recipients will have to tighten their belts a bit—and maybe start voting for candidates who offer real solutions to the budget issues in Washington. But as I've told my clients for years, no one is going to vote for anyone who favors allowing the system to go bankrupt, or not pay the promised benefits. Members of congress really like keeping their jobs, and eventually they'll find the right solutions.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

https://www.ssa.gov/oact/TR/2018/index.html

https://www.infoplease.com/us/mortality/life-expectancy-age-1850-2011

https://www.nola.com/national_politics/2018/06/medicare_finances_worsening_tr.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Sunday
Jun102018

Adding inSALT to Tax Injury

Ever since I became a tax preparer in 1980, a federal deduction for state and local income, property or sales taxes have been available to taxpayers as an itemized deduction, generally without limitation. The idea behind the deduction, at least as it relates to state income taxes, is to grant taxpayers some degree of relief from double or triple taxation of the same income.

Of course, each year, thousands of professionals use their creativity and ingenuity to try to figure out the best ways to lower your federal taxes, including optimization of your state and local tax deduction. You know you’re living in interesting times when state lawmakers join that crowd.

The reason they’re working so hard is something popularly known as the SALT (State And Local Taxes) provisions of the new Tax Cuts + Jobs Act, which set a firm $10,000 limit on the deductibility of state and local taxes. That limit isn’t such a big deal for residents of Texas or Florida, and other states that don’t collect income taxes. But people living in New York, New Jersey, Connecticut and California generally pay far more than $10,000 of income taxes to the state alone, on top of the property and municipal taxes they’re assessed.

Those higher-tax states are now using that aforementioned creativity and ingenuity to help their citizens get back those deductions—and some of the proposed solutions are indeed quite creative. For instance, New York has already begun allowing taxpayers to, instead of paying their local property taxes, simply make a comparable charitable contribution to a charity set up by their local school district. Presto chango! What used to be a tax is now a charitable contribution that would be deductible for taxpayers who itemize (limited to a maximum of 50% of adjusted gross income). The state would also allow New York City and other municipalities to set up their own charitable trusts, converting local taxes into deductible charitable contributions as well.

Not to be outdone, New Jersey and Connecticut are attempting to reclassify state taxes as charitable contributions, while New York plans to allow taxpayers to convert their state income tax into a payroll tax, which their employers would pay on their behalf—and then deduct from their federal tax bill.

Even more creative: California’s Senate Bill 227 would create something called the “California Excellence Fund,” which would provide a credit against state income tax liability for any contributions to the fund—effectively recharacterizing as much of the state tax liability as the resident wants into deductible charitable donations. Similar legislation has been introduced in Illinois, Nebraska and Virginia. In Washington state, which doesn’t levy an income tax, a copycat bill would let taxpayers make charitable contributions to the state and receive a sales tax exemption certificate in return.

The most complicated solution is being proposed in Connecticut, whose legislature is finalizing a bill that would impose an “entity-level” tax on pass-through companies like Subchapter S corporations and LLCs—entities which normally are only taxed at the shareholder level. (Hence the name “pass-through.”) Those entity-level taxes would be deductible by the S corp. or LLC, and the state would issue an offsetting individual income tax credit to shareholders of the entity. Presto! The state income tax becomes deductible at the company level, and the individual’s state income tax obligation goes away. Connecticut’s Department of Revenue Services estimates that this provision would recover $600 million in otherwise-lost SALT deductions for state residents in the first year alone.

Is any of this legal? We don’t know yet. The IRS has recently issued a broad warning against states’ creative use of charitable contributions, and it never helps a future tax court case when lawmakers openly tout their intentions to evade the federal SALT provisions when they introduce state legislation. But tax experts note that the IRS has provided favorable rulings in more narrow cases regarding the federal deductibility of state tax credits in 33 states.

For instance, Alabama has, for years, provided a 100% state tax credit for taxpayers who donate money to organizations that give children vouchers to attend private school. New York’s new SALT-related provision would give an 85% state tax credit to residents who donate to a local charitable fund that supports education. Is one legit but the other not?

There's little doubt that some of these provisions would be challenged in court, so get ready for some of your tax dollars to be spent to help the government keep and collect more of your tax dollars.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

Sources:

https://www.nytimes.com/2018/05/23/us/politics/irs-state-and-local-tax-deductions.html

https://taxfoundation.org/more-dubious-salt-workarounds/

https://www.bondbuyer.com/news/eight-states-may-follow-new-yorks-workaround-for-salt-deduction-limits

http://www.taxanalysts.org/content/connecticut-finds-salt-workaround-would-actually-work

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Tuesday
May292018

"Curve" Your Enthusiasm?

When I was starting out in the financial planning business, I used to listen to smart people who spewed out catchy phrases like "inverted yield curve", "risk-free rate", and "henway". Back then, I didn't really understand much of the lingo, so I was fortunate that all this "gibberish" was only a web-search away. In my discussions these days, I try and avoid jargon as much as possible and strive to distill financial concepts into their simplest components. Today is one such attempt to explain the inverted yield curve and its effect on the economy and markets.

This so-called "best" indicator of a future recession, the inverted yield curve, is not perfect and doesn’t provide an exact time or date. But economists have found that an inverted yield curve can be a warning sign of an economic downturn to come.

Again, an inverted what??? The yield curve is a line graph of the yield (i.e., interest rate) of treasury bills (bonds) from the very short term—one month, three months, six months, 1, 2, 3, 5, 7, 10 and all the way out to 30 years. A normal curve is sloped upward—for obvious reasons: the longer the maturity of the bond, the more the borrower should have to pay to compensate you for the risks of inflation and future interest rate movements. The 3-month treasury bill should pay at least incrementally more than the 1-month treasury bill, and on up the maturity range.

Deviations from this obvious hierarchy, called "inversions", are rare—as it turns out, just about as rare as recessions. This would be akin to walking into a bank and accepting a lower interest rate on a 2-year certificate of deposit (CD) than on a 1-year CD. Few would ever do that (especially since the penalties for early withdrawal are a bit steep).

Since 1955, long-term bonds yielded less than short-term ones before every single U.S. recession. Nobody knows exactly why a spate of market illogic should be followed by economic pain; there are theories, but the cause/effect is uncertain.

Unfortunately, the inversions in the past have occurred anywhere from 6 months to 24 months before the actual recession, so this is not exactly a precise timing mechanism. But perhaps we should consider the next yield inversion as a time to buckle our seat belts on the investment roller coaster.

Yield Curve Movement 2018-05-26

So where are we now? The above chart shows the current yield curve (red) compared with a week ago (blue), a month ago (green) and a year ago (orange). As you can see, the curve has flattened in the past 12 months, not to the point of inversion, but certainly a narrower spread (i.e., difference between yields). If you want to watch to see if there is further flattening, here’s one website that tracks the curve in real-time: https://www.bondsupermart.com/main/market-info/yield-curves-chart.

Now, when someone utters the phrase "inverted yield curve", you can nod in understanding. And if they ask what's the risk-free rate, you can tell them it's the current yield on the 10-year treasury note.

Finally, if anyone asks "what's a henway", you tell them "oh, a hen weighs about three or four pounds".

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

https://www.bondsupermart.com/main/market-info/yield-curves-chart

https://www.forbes.com/sites/johnmauldin/2018/05/01/almost-all-recessions-began-6-to-24-months-after-the-yield-curve-inverted/#2550ecfa6742

 https://thefelderreport.com/2018/04/26/how-the-flattening-yield-curve-could-lead-to-a-bear-market-for-stocks/

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Sunday
May062018

The Present Doesn't Portend the Future

You probably know the well worn disclaimer in the investing world, "past performance is no guarantee of future results." It's essentially how many investment firms wow you with statistics about their past performance, only to remind you that your future results may never match theirs. OK, fair enough, so how about present circumstances? Do they portend the future?

It's human nature to focus more on the present than the future, which is in line with our basic instinct of survival. After all, if we don't take care of the here and now, there may not be a future, right?

Marketing departments know this! Many things in life are about experiencing pleasure today, and pushing the cost of that pleasure into the future (credit cards anyone?). Drive off with the car with zero dollars down, and pay over 84 months. Go ahead--have another piece of cake - you can work it off later. No problem.

Many decisions investors face have similar tradeoffs. Buy a new car, or put more money into retirement? Take another vacation or fund the college account? And the further out the consequence, the less weight we tend to give to it. This is because we have a hard time imagining the future…especially way into the future.

Smart Today May Not Be Smart Tomorrow

We tend to extrapolate the present into the future, as if things will never change and will continue the status quo.

In the financial crisis of 2008-2009, many people were selling after experiencing financial losses. Some of that selling came just weeks before the market hit bottom. What would cause an investor, who desires to buy low and sell high, to sell after experiencing significant (yet unrealized) losses (i.e. sell low)? One factor is that they were extrapolating the present into the future…they couldn’t see how things would change.

Another great example is the German Bund (treasury bond). In 2016, Germany sold the 10-year Bund at a negative yield (this means that buyers were guaranteed to get back less principal than they originally put in). Those investors were certain that rates would continue going negative for the next 10 years. But here we are almost two years later and the current yield is already over +0.50%. Substantial money (principal) may be lost on this bond simply because investors extrapolated the "present of 2016" into the future.

More recently, the stock markets have struggled to continue the torrid advance that began with the presidential election in 2016, lasting through this past January. The markets had a handful of "1% days" during a low volatility year in 2017, yet so far in 2018, we've had more 1% days than all of 2017 as volatility has returned. While the markets haven't yet closed more than 10% from their January peak, you've probably read or heard the prognosticators calling this correction the beginning of the end for the bull market. Enough investors will be scared witless of enduring another 2008-2009 selloff that they'll sell now and probably miss the next great advance that makes another new all-time high sooner than they can presently imagine.

History May Help Here

Think about everything that has happened in the last 10 years--of course, a lot has happened. And while we may not be able to project what will happen in the future, how it will happen or when, we know – through the history of mankind - that lots of unexpected things will occur. Another crisis is always bound to come along.

The plans that we have developed for our clients prepare them for many different scenarios. They take into account their risk tolerance, time-frame and overall monetary goals and dreams.  But we don’t have to get any one scenario right. We just need to be disciplined enough to stick with the plan through both the good and the tough times.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: Information obtained from The Emotional Investor