No More Plow Horse

Brian Wesbury, Chief Economist of First Trust gives his take on the economy under the Trump Administration.

We’ve called the slow, plodding economic recovery from mid-2009 through early 2017 a Plow Horse. It wasn’t a thoroughbred, but it wasn’t going to keel over and die either. Growth trudged along at a sluggish – but steady – 2.1% average annual rate.

Thanks to improved policy out of Washington, the Plow Horse has picked up its gait. Under new management, real GDP grew at a 3.1% annualized rate in the second quarter of 2017 and 3.2% in the third quarter. There were two straight quarters of 3%+ growth in 2013 and 2014, but then growth petered out. Now, it looks like Q4 clocked in at a 3.3% annual rate, which would make it the first time we’ve had three straight quarters of 3%+ growth since 2004-5.

Some say a government shutdown would make it tough to get another 3% quarter to start 2018, but we disagree. Yes, some “nonessential” government workers might pull back on their spending temporarily, but there’s no historical link between government shutdowns and economic growth.

The economy grew at a 2.8% annual rate in late 1995 and early 1996 during the two quarters that include the prolonged standoff under President Clinton. That’s essentially no different than the 2.7% pace the economy grew in the year before the shutdowns. The last time we had a prolonged standoff was in late 2013, under President Obama. The economy grew at a 4% rate that quarter, one of the fastest of his presidency.

Right now, taxes are falling, regulations are being reduced, and monetary policy remains loose. With these tailwinds, the acceleration of growth in 2017 should continue into 2018.

 

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General Electric News

General Electric, once one of the world’s biggest conglomerates, may be on the verge of breaking up.

GE was the worst performer in the Dow Jones Industrial Average (DJIA) in 2017. From Yahoo Finance:

2017 was a painful year for investors in General Electric (NYSE: GE) as they watched shares of the industrial stalwart crumble. The last quarter of the year was particularly difficult when GE stock lost nearly 28% in value, ending 2017 down a whopping 44.8%. Dismal numbers, top management churn, a dividend cut, a major portfolio restructuring in the works …

GE investors who depended on the dividend saw their income cut by 50%.

Despite the dividend cut, thanks to an equally sharp drop in the price of the stock, GE remains one of the top 10 yielding stocks in the DJIA.

And now there is talk about breaking GE up into separate companies. From CNBC:

“GE has started down the road to breaking itself up,” tweets CNBC’s David Faber, noting the CEO’s comments this morning on the investor call. “People close to the company tell me that outcome is likely with an announcement possible as soon as this Spring.”

From Seeking Alpha:

Nelson Peltz’s Trian Fund Management, which has seen its investment in GE decline 30% since when he bought into the company in 2015, is pushing the conglomerate to explore possible sales or spinoff of many of its businesses, including those in health and power, sources told the New York Post.
Trian founding partner and GE director Ed Garden has been spending much time recently with GE Chief Executive John Flannery, and it’s Trian that is behind GE’s decision to explore such sales.

What does this mean for GE shareholders? Management and the Board of Directors are working hard to enhance shareholder value. It remains to be seen if they are successful.

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Don’t Time a Correction

Brian Wesbury, Chief Economist, First Trust:

The stock market is on a tear. The S&P 500 rose 19.4% in 2017 excluding dividends, and is already up over 4% in 2018. It’s not a bubble or a sugar high. Our capitalized profits model, says the broad U.S. stock market, is, and was, undervalued.

We never believed the “sugar high” theory that QE was driving stocks. So, slowly unwinding QE and slowly raising the federal funds rate, as the Fed did in 2017, was never a worry. But, now a truly positive fundamental has changed – the Trump Tax Cut, particularly the long-awaited cut in business tax rates. With it in place, we think our forecast for 3,100 on the S&P 500 by year-end is not only in reach, but could be eclipsed.

Before you consider us overly optimistic, we did not expect the stock market to surge like it has so early in the year. In fact, we would not have been surprised if the market experienced a correction after the tax cut. There’s an old saying; “buy on rumor, sell on fact.” So, with tax cuts approaching, optimism could build, but once they became law, the market would be left hanging for better news.

We would never forecast a correction, because we’re not traders. We’re investors. Anyone lucky enough to pick the beginning of a bear market never knows exactly when to get back in. In 2016, it happened twice and we know many investors are still bandaging up their wounds from being whipsawed.

The market got off to a terrible start in 2016, one of the worst in years. The pouting pundits were talking recession and bear market, only to experience a head-snapping rebound. Then, during the Brexit vote, the stock market fell 5% in two days – which was seen as another indicator of recession. But, it turned out to be a great buying opportunity, like every sell-off since March 2009.

The better strategy for most investors is don’t sell. Some sort of correction is inevitable but no one knows for sure when it will happen and few have the discipline to take advantage of the situation.

This is particularly true when risks to the economy remain low and the stock market is undervalued, which is exactly how we see the world today.

Earnings are strong (even with charge-offs related to tax reform), and according to Factset, since the tax law passed analysts have lifted 2018 profit estimates more rapidly than at any time in the past decade. Even the political opponents of the tax cuts are saying it will likely lift economic growth for at least the next couple of years.

Continuing unemployment claims are the lowest since 1973, payrolls are still growing at a robust pace, and wages are growing faster for workers at the lower end of the income spectrum than the top. Auto sales are trending down, but home building has much further to grow to keep up with population growth and the inevitable need to scrap older homes. Consumer debts remain very low relative to assets, while financial obligations are less than average relative to incomes.

In addition, monetary policy isn’t remotely tight and there is evidence that the velocity of money is picking up. Banks are in solid financial shape, and deregulation is going to increase their willingness to take more lending risk. The fiscal policy pendulum has swung and the U.S. is not about to embark on a series of new Great Society-style social programs. In fact, some fiscal discipline on the entitlement side of the fiscal ledger may finally be imposed.

Bottom line: This is not a recipe for recession.

It’s true, rising protectionism remains a possibility, but we think there’s going to be much more smoke than fire on this issue, and that deals will be cut to keep the good parts of NAFTA in place.

Put it all together, and we think the stock market, is set for much higher highs in 2018. If you’re brave enough to attempt trading the inevitable ups and downs of markets, more power to you, but as hedge fund performance shows, even the so-called pros have a hard time doing this. Stay bullish!

 

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Can you answer these basic money questions?

The NY Post published an article Most Americans can’t answer these 4 basic money questions.   They questioned “Millennials” and “Boomers” to see who were most knowledgeable about investing.

Here are the questions – see how well you do.

  1. Which of the following statements describes the main function of the stock market?
    A) The stock market brings people who want to buy stocks together with people who want to sell stocks.
    B) The stock market helps predict stock earnings
    C) The stock market results in an increase in the price of stocks
    D) None of the above
    E) Not sure
  2. If you had $100 in a savings account and the interest rate was 2 percent per year, after 5 years, how much do you think you would have in the account if you left the money to grow?
    A) Exactly $102
    B) Less than $102
    C) More than $102
    D) Not sure
  3. If the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year, after 1 year, how much would you be able to buy with the money in this account?
    A) More than today
    B) Exactly the same as today
    C) Less than today
    D) Not sure
  4. Which provides a safer return, buying a single company’s stock or a mutual fund?
    A) Single company’s stock
    B) Mutual fund
    C) Not sure
    D) Not sure

 

 

The correct answers are

  1. A
  2. C
  3. C
  4. B

If you had trouble getting the right answers you could benefit from the guidance of a good RIA (Registered Investment Advisor).

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Retirement: there’s good news and bad news.

First, the good news. According to a leading investment firm, current retirees are doing just fine. They studied a large group of retirees. They’re doing very well.  The group that retired about 20 years ago have about 80% of their retirement savings intact. In fact, one-third of these retirees have more money than when they retired.

But here’s the bad news. These retirees are different from those retiring today or those just beginning their careers. Their experiences are different and so are their resources.

If you have been retired for 20 years that makes you about 85 years old. These older retirees grew up during the “Great Depression” and that had a lifelong impact on them. Their experience made them lifelong savers. Many also worked for companies that provided their employees defined benefit pension plans.

This means is that many of these pensioners have two sources of income: a company pension and social security. Living within their means, they were able to leave their personal retirement assets untouched.

Some of the more affluent may have bought vacation homes which have appreciated in value. Others have begun gifting to their children and grandchildren.

We can’t infer from their success that newer retirees will do nearly as well. There are several reasons why. Except for government employees, few private sector employees have defined benefit pension plans. Social Security is under pressure and will simply not have enough in the Trust Fund to continue to pay retirees at the same rate as current retirees. Medicare is also running large deficits which will result in higher medical expenses for the elderly.

New and future retirees will not have private pensions, face lower social security income and higher medical expenses. Only saving and investing wisely will save them.

For more information contact us.

 

 

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Revolution

Our favorite economist, Brian Wesbury of First Trust, comments on the changes taking place in the economy:

One word that could describe Donald Trump’s unexpected ascendancy to the presidency is – “revolt.” Revolt against the “establishment.” Revolt against the “status quo.”

After all, status quo bureaucracies, tax rates, institutions, regulations, and narratives promised prosperity, yet the economy was mired in slow growth and many felt it was hard to get ahead. Reliably blue states tilted red, and the pendulum swung the other way.

Since 1993, the top federal tax rate on US corporations has been 35%, one of the highest in the world. This has forced US companies to expand overseas. Both sides of the political spectrum knew it was a problem, yet nothing was ever done.

Now the rate is 21%, and full expensing of business investment for tax purposes is law. These changes will boost the incentive to invest and operate in the US, leading to more demand for labor, which means lower unemployment and faster wage growth, as well. From an economic perspective, this is a revolution.

But there’s more. We’re referring to the new limit for state and local tax deductions. That change, combined with a larger standard deduction, will launch an overdue revolution in the policy choices of high tax states as well as the geographical distribution of business activity.

California’s top marginal income tax rate is 13.3%. Under the old tax system, tax payers who itemize could deduct their state income taxes from their taxable federal income. So for the highest earners, the effective marginal rate was 8.0%, not 13.3%. [Deducting 39.6% of 13.3% saved them 5.3%. 13.3% minus 5.3% is 8.0%.]

Politicians in California could raise state income tax rates, and up to 39.6% of the cost would be carried by taxpayers in other states. The same goes for New York City residents, where the top income tax rate is roughly 12.7%.

Now taxpayers are limited to $10,000 in state and local tax deductions (with a 37% top federal tax rate). The financial pain of living in high tax states is now exposed. California and New York City – and many other high tax jurisdictions – look a lot less attractive than states like Texas, Florida, and Nevada.

This change may limit the measured income and wealth gap in the US between the rich and poor. California and New York don’t just have high taxes, they also have a high cost of living. So, if some high earners in these places leave to take lower pay in places with lower taxes and a lower cost of living, the income and wealth gap would narrow.

But incentives work on all institutions, and policymakers in high-tax states have massive pressure to cut tax rates.

Meanwhile, the Supreme Court is set to rule on Janus vs. American Federation of State, County, and Municipal Employees. Based on a similar case from a few years ago, it’s likely the Court will rule that all government workers (state, local and federal) will have a choice to pay union dues, or not. We know from experience that, when given a choice, many workers stop supporting the political activities of unions. This would be another force significantly altering the balance of power.

Whether you agree with these developments or not, the U.S. hasn’t seen economic policy changes like this in a long time. The forces that support markets and entrepreneurship over government control are reasserting themselves.

 

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What are mutual fund share classes and why are they important

Mutual fund share classes are little understood by the investing public, but they are important because they determine how much the investor pays in fees.

Fund classes are identified by an alphabetical letter that follows a mutual fund’s name in most newspapers.

Mutual fund “A” share classes typically have a “front-end load,” a sales charge payable when you buy the fund. This fee is used to pay the brokerage firm and part of it goes to the broker who sells the fund.

The amount of the load depends on the kind of fund – bond funds generally have lower loads than stock funds – and the amount of money invested. The more money that’s invested, the lower the fee. Known as “break points,” they refer to points at which front-end charges go down. For example, the front-end load for the Growth Fund of America class A shares is 5.75% on investments up to $25,000. But if you invest $1 million dollars or more the front-end load is 0%.

Mutual fund “B” shares typically have a “back end load” payable when you redeem the shares. These decline over a period of years (usually 6 to 8 years) until they finally disappear.

Both “A” and “B” shares usually have an “12b-1” marketing fee, generally 0.25%, charged annually.

Class “C” shares have no front-end load, a small back end load, usually 1%, that goes away after 1 year. However, they have higher 12b-1 fees, typically 1%.

There are other share classes such as I, Y, F-1, F-1, F-2. In fact, some funds have as many as 18 share classes. They are all the same fund; the only difference is the fee charged to the investor.

Many fund families offer “institutional” share classes that are only available to certain investors. Institutional shares are purchased by businesses who are in the investing business such as banks, pension funds, insurance companies and registered investment advisors (RIAs) who buy them as agents for their clients. This is one of the benefits of working with an independent RIA who has access to lower cost funds, load waived funds and no-load funds that are often not offered by the major Wall Street firms.

Contact us for more information.

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Six Charitable Moves to Consider Before Year-End

The tax changes in the Tax Cuts and Jobs Act (TCJA) are extensive and far-reaching.  The standard deduction will be raised starting in 2018, which means that going forward taxpayers will need to provide more itemized deductions in order to receive the tax benefit of excess deductions.  If you are charitably inclined, you should to consider these six charitable planning moves before the end of the year given the impending changes to the tax code.

 

If you itemize your taxes:

  1. Donate highly appreciated stocks or mutual funds. The stock market has been on a terrific run, and you may have highly appreciated stocks or mutual funds that you are holding on to because you do not want to pay capital gains taxes.  By donating appreciated investments, you avoid paying the capital gains tax and can take a deduction for the fair market value of the investments.  If you are considering gifting mutual funds, do so before they declare their year-end dividends and capital gains and you will save on taxes by avoiding that income as well.  While your deduction is limited to 50% of your Adjusted Gross Income (AGI), you can carry the unused portion to future tax years.
  2. Consider bumping up this year’s contributions: essentially, make contributions that you would have made in 2018 before the end of 2017. The rationale here is that your tax rate is likely to be lower next year than it is this year due to the TCJA, so every additional dollar given this year is deducted against your higher current 2017 rate.
  3. If you want to create a legacy or are unsure of where to contribute, use a Community Foundation or Donor Advised Fund (DAF) to max out your contributions. For example, if you give $50,000 to a DAF, you can deduct the entire amount now but designate your gifts and charities over time.  You can invest the portion of your DAF that is not immediately donated to a specific charity, creating the potential for even greater giving in the future.
  4. If you are considering an even larger donation, or are interested in asset-protection, you may want to consider creating either a charitable lead or remainder trust. With a charitable remainder trust, you get a deduction for your gift now; generate an income stream for yourself for a determined period of time; and at the expiration of that term, the remainder of the donated assets is distributed to your favorite charity or charities.  A charitable lead trust is essentially the inverse of the remainder trust: you get a deduction for your gift now; generate an income stream for one or more charities of your choice for a determined period of time; and at the expiration of that term, you or your chosen beneficiaries receive the remaining principle.  The deduction you receive is based on an interest rate, and the low current rates makes the contribution value high.
  5. Donate your extra property, clothes, and household items to charity. Make time to clean out your closets, spare bedroom and garage, and donate those items to one of the many charitable organizations in our area.  CHKD, Salvation Army, Purple Heart, ForKids, Hope House are just a few organizations that will take old clothes, appliances, household items and furniture.  Some of them will even come to you to pick up items.  Make sure to ask the charity for a receipt and keep a thorough list of what you donated.  You can use garage sale or thrift store prices to assign fair market values to the donated items, or you can use online programs (such as itsdeductible.com) to figure out values.

 

If you are over age 70 ½:

  1. Make a Qualified Charitable Distribution (QCD).  Essentially a QCD allows you to donate all or a portion of your IRA Required Minimum Distribution to a qualifying charity.  The donated amount is not included in your taxable income and also helps to lower your income for certain “floors” like social security benefit taxation and Medicare Part B and Part D premiums.  QCDs are very tax-efficient ways to make charitable donations.

A prediction for 2018 from Brian Wesbury of First Trust

Last December we wrote “we finally have more than just hope to believe that this year, 2017, is the year the Plow Horse Economy finally gets a spring in its step.” We expected real GDP growth to accelerate from 2.0% in 2016 to “about 2.6%” in 2017. Our optimism was, in large part, based on our belief that the incoming Trump Administration would wield a lighter regulatory touch and move toward lower tax rates.

So far, so good. Right now, we’re tracking fourth quarter real GDP growth at a 3.0% annual rate, which would mean 2.7% growth for 2017 and we expect some more acceleration in 2018.

The only question is: how much? Yes, a major corporate tax cut (which should have happened 20 years ago) is finally taking place. And, yes, the Trump Administration is cutting regulation. But, it has not reigned in government spending. As a result, we’re forecasting real GDP growth at a 3.0% rate in 2018, the fastest annual growth since 2005.

The only caveat to this forecast is that it seems as if the velocity of money is picking up. With $2 trillion of excess reserves in the banking system, the risk is highly tilted toward an upside surprise for growth, with little risk to the downside. Meanwhile, this easy monetary policy suggests inflation should pick up, as well. The consumer price index should be up about 2.5% in 2018, which would be the largest increase since 2011.

Unemployment already surprised to the downside in 2017. We forecast 4.4%; instead, it’s already dropped to 4.1% and looks poised to move even lower in the year ahead. Our best guess is that the jobless rate falls to 3.7%, which would be the lowest unemployment rate since the late 1960s.

A year ago, we expected the Fed to finally deliver multiple rate hikes in 2017. It did, and we expect that pattern will continue in 2018, with the Fed signaling three rate hikes and delivering at least that number, maybe four. Longer-term interest rates are heading up as well. Look for the 10-year Treasury yield to finish 2018 at 3.00%.

For the stock market, get ready for a continued bull market in 2018. Stocks will probably not climb as much as this year, and a correction is always possible, but we think investors would be wise to stay invested in equities throughout the year.

We use a Capitalized Profits Model (the government’s measure of profits from the GDP reports divided by interest rates) to measure fair value for stocks. Our traditional measure, using a current 10-year Treasury yield of 2.35% suggests the S&P 500 is still massively undervalued.

If we use our 2018 forecast of 3.0% for the 10-year yield, the model says fair value for the S&P 500 is 3351, which is 25% higher than Friday’s close. The model needs a 10-year yield of about 3.75% to conclude that the S&P 500 is already at fair value, with current profits.

As a result, we’re calling for the S&P 500 to finish at 3,100 next year, up almost 16% from Friday’s close. The Dow Jones Industrial Average should finish at 28,500.

Yes, this is optimistic, but a year ago we were forecasting the Dow would finish this year at 23,750 with the S&P 500 at 2,700. This was a much more bullish call than anyone else we’ve seen, but we stuck with the fundamentals over the relatively pessimistic calls of “conventional wisdom,” and we believe the same course is warranted for 2018. Those who have faith in free markets should continue to be richly rewarded in the year ahead.

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Me and my spouse are approaching retirement; how should we allocate our investments so that we can protect some and grow some?

This was a question asked by a visitor to Investopedia.
Several other advisors responded.  Here’s my contribution to the discussion.
 

You have gotten some good advice from the others who have responded.  The only advice I would add to theirs is that the years just prior to retirement and the first few years of retirement are the most critical years for you.  These are the years when significant investment losses have the biggest impact on your retirement assets.

That’s because of something referred to as “sequence of returns.”  “Sequence of returns” refers to the fact that market returns are never the same from year to year.  For example, here are the returns for the S&P 500 from 2000 to 2010.  That was a dangerous decade for retirees.

2000 -9.1%
2001 -11.9%
2002 -22.1%
2003 28.7%
2004 10.9%
2005 4.9%
2006 15.8%
2007 5.5%
2008 -37.0%
2009 26.5%
2010 15.1%

When you are accumulating assets, the sequence of returns has no impact on the amount of money you end up with.  But when you are taking money out, the sequence becomes very important.  That’s because taking money out of an account exaggerates the effect of a market decline.

If you retired in the year 2000 with $100,000 and took out 4% ($4000) to live on each year, by 2010 your account would have shrunk to about $66,200 and, if you continued to withdraw the same amount each year you would now be taking out 6%.  If you have another 30 years in retirement, that rate of withdrawal may not be sustainable.

For that reason, most financial advisors recommend creating a portfolio that can cushion the effect of poor market performance near your retirement date.

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