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Economic/Financial Updates

Explore our in-depth analysis and commentary on economic conditions.

Where Do Your Tax Dollars Go?

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As you look back on your tax payments for calendar year 2016, you’re undoubtedly wondering where those dollars are being spent.


The Wall Street Journal recently published a report that breaks down government spending for every $100 of tax receipts. The report concluded that the U.S. government is, in reality, a large insurance company that also happens to have an army.


For every $100 you pay in taxes, $23.61 goes to Social Security payments and administration – basically insurance for retirees. Another $15.26 goes to Medicare, the government health insurance program. Medicaid, the health insurance program for the poor, accounts for another $9.55 of that $100 tax bill – bringing the total costs for various civilian insurance programs to 48% of the total budget.


And that army? It costs $15.24 of every $100 the government collects in taxes, not counting veterans benefits.


In all, the 2016 federal budget fell $15.24 short out of every $100 of revenues equaling expenses. So where would you cut?


Things like federal expenditures and grants for education ($2.08), food stamps ($1.89), affordable housing ($1.27) and foreign aid ($1.14) actually make up a very small part of the budget, smaller than interest payments on the national debt ($6.25).


There has been talk about helping reduce the budget by lowering expenditures on the National Endowments for the Arts and Humanities, which together represent eight-tenths of one cent of that $100 tax bill. This would be comparable to someone trying to pay off his mortgage by looking for coins under the sofa cushions!



Special thanks to Bob Veres for his commentary

Brexit is Beginning

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If you have a good long memory, you may recall that last summer, the U.K. panicked the investment markets by voting, in a nation-wide referendum, to exit the European Union. There were, of course, dire predictions about the impact on the U.K. economy, which never materialized, in large part because the U.K. had not yet formally opted out of its Eurozone agreements.


At the end of March, the U.K. finally pulled the trigger and made the departure from the European Union official. The Queen of England delivered her royal assent, and the U.K.’s envoy to the European Union hand-delivered a letter to the office of the European Council president in Brussels invoking Article 50 of the EU treaty. This delivered formal notification of the Brexit decision, the first time this has happened in the EU’s history.



So that means those dire predictions will finally come true. Right?


As it happens, Article 50 was intended to prevent any rash or immediate consequences of an exit from EU membership, and it seems to have accomplished that goal. Under the bylaws, the divorce will be negotiated, item by item, over the next two years, meaning that any change in economic circumstances will be gradual and perhaps accommodated as they happen. How gradual? Over the next several weeks, the EU’s remaining 27 members will discuss their priorities in advance of the negotiations, and then hold a summit on April 29. Only then will the European Commission have a mandate to negotiate with representatives from London.


What will the negotiations cover? First up will be Britain’s obligations to the EU for its participation thus far—a bill that could total up to roughly $65 billion. Also: what will be the rights of 3 million EU citizens living in the U.K., and the rights of more than 1 million Britons living and working in the Eurozone?


After that, it is speculated that the British government will seek to negotiate a broad free-trade agreement which will effectively replicate the provisions of its former membership in the European Union, as a way to protect its commercial ties with the Continent. This is where negotiations will get sticky, since France and Germany will almost certainly oppose a no-consequences exit, and they will want to protect their own economies’ free-trade access to Eurozone markets. On the EU side, a simple majority of countries will decide what proposals are accepted and which are sent back to the negotiating table—with one notable exception: any free trade agreement between the two sides much win unanimous approval.


This latter issue is problematic for the U.K., because it exposes each country to yet another referendum on the conditions of EU membership; the citizens of France, Germany, Luxembourg, Ireland, Holland and, well, all the other nations would want to be involved in the final decision, which would give them yet another opportunity to voice displeasure with the EU and stir up nationalistic parties and sentiments.


Also still to be determined are budgetary considerations. The U.K.’s contribution to the governing infrastructure of the EU will have to be made up by the remaining members, whose citizens are not eager to contribute more to the increasingly unpopular entity. The British government, meanwhile, will have to create an expensive governance infrastructure to replace the EU bureaucracy in Brussels, and Parliament will have to formally repeal the European Communities Act of 1972, making EU law U.K. law. Then, parallel with the EU negotiations, Parliament will debate every aspect of the EU law and decide which to keep long-term and which to drop. That, too, will take years.


The bottom line is that nothing dramatic is likely to happen, economically and in the investment markets, for years. Throughout the two years of negotiations, the U.K. will remain a full EU member, albeit without a chance to participate in EU decision-making. Some are predicting that the discussions will last for several additional years, with extensions on the status quo until issues can be ironed out. Unpicking 43 years of treaties and agreements covering thousands of different subjects will not be an easy task.


Those investors who overreacted to the initial (and shocking) Brexit vote sold their stocks into a market rally, and there is no reason to think that those who might panic now that the trigger is finally pulled will fare any differently. Both sides in this negotiation have a stake in not having anything dramatic—particularly dramatically damaging—from happening, and they will probably succeed in making Brexit a boring exercise in bureaucratic handover.


Special thanks to Bob Veres for his commentary.

Fed Announces Rate Hike

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As the U.S. economy and the stock market continue to see sustained growth, the Federal Reserve has elected to increase the interest rates once again. Just as in December, the latest Fed rate hike is quite conservative: an increase of 0.25%, to a range of 0.75% to 1%. As indicated in the chart, the rates remain historically low.



While the Fed’s decision to move forward with another modest rate hike was not surprising, the more consequential aspect of this story is their intention to gradually increase the rates over the next several years.


The below dot plot illustrates the interest rates that have been projected by each of the 17 Federal Reserve policy board members.



The majority of policy board members said they believe the interest rates should be increased to a range of 1.25-1.5% by the end of 2017 – indicating that we could see two or three more rate hikes before the end of the year. By the end of 2019, the Fed policy board anticipates an interest rate of about 3% – a considerable increase from the current rates, but a fairly moderate rate when compared to historical levels.


The latest interest rate projections are consistent with the Fed’s December projections, reflecting the Fed’s overarching goal of tying future rate increases to U.S. economic progress.


How Does the Rate Hike Affect You?

The rise in rates is good news for those who believe that the Fed has intruded on normal market forces by suppressing interest rates much longer than could be considered prudent, and even better news for people who are bullish about the U.S. economy.


However, bond investors might be less enthusiastic, as higher bond rates mean that existing bonds lose value. The recent rise in bond rates suggests that the bull market in fixed-rate securities may finally be waning.


The impact on stock investors is more complex. Bonds and other interest-bearing securities compete with stocks, in the sense that they offer stable returns on your investment. As interest rates rise, some stock investors could be inclined to move a portion of their investments into the bond market – reducing demand for stocks and potentially lowering future returns.


As the Fed contemplates more rate hikes in 2017 and 2018, our family team of advisors will continue to closely monitor the market and offer recommendations that reflect your current situation and future objectives.


Federal Reserve/Washington Post
Federal Open Market Committee/Financial Times

START – A Guide to the U.S. Economy

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By Logan Curti, Lynn A. Ferraina and Jasen Gilbert, CFP®
Based on the January 29 presentation by Garrett D’Alessandro, CEO of City National Rochdale


In the midst of a major transition within our government – the inauguration of President Trump and initiation of a Republican-controlled Congress – many people have expressed uncertainty about the economic conditions that face our nation.


START is an acronym that serves as a useful tool for predicting U.S. economic performance as it relates to our government. Stimulus, Taxes, Attitude, Regulation and Trade are directly impacted by congressional legislation and executive action.


By understanding the interplay between public policy and economic factors, we are able to make informed predictions about the outcomes for investors. We have compiled this article to guide you through the economic landscape over the upcoming years.




Perhaps the most effective way to stimulate the U.S. economy is through increased spending by the government, consumers and corporations.


In terms of public-sector spending, defense and infrastructure spending serve as the foundation for stimulus efforts. As part of our nation’s $18 trillion annual GDP in 2016, about $450 billion was spent on infrastructure projects, whereas more than $600 billion was spent on national defense1.


Infrastructure spending creates well-paying middle-class jobs, and our country has a pressing need for modernization. However, infrastructure projects have a gradual effect on our economy; building a new bridge or upgrading a water system can take several years, and we do not feel the full impact of the stimulus until the project is completed. On the other hand, increased defense spending serves as a means for immediately stimulating the U.S. economy.


The U.S. economy is currently entering its 92nd consecutive month of economic expansion – the longest streak of growth since the 1990s. During the past eight years of expansion, we have experienced a modest but steady rate of GDP growth (between 2-2.25% in annually)2.


Based on the campaign platform of President Trump and the GOP, the U.S. may increase defense and infrastructure spending. This suggests that there may be a low likelihood of recession during the next 18 months.


While the government plays a less direct role in determining consumer spending, about 65-75% of our economy is driven by consumers3 – buying groceries, automobiles, clothing, housing, etc. Healthy consumer fundamentals will help to boost economic growth. Given that the U.S. has a low unemployment rate (4.8%)4 and the lowest level of consumer debt since the early 1980s5, consumer spending may also be on the rise during 2017.


Another critical component of our economy is corporate spending. As a result of business-friendly reforms on taxes and regulations (discussed in the following section), corporations may have more buying power under President Trump.




When Congress and the President discuss tax reform, there are two distinct areas of conversation: the tax rates and the tax code. The two parties have different priorities in regards to tax reform, with Trump emphasizing tax cuts more heavily and Congress more focused on simplifying the tax code.


Given that our tax code is more than 10,000 pages long and is full of pork for corporate interests, reform will be a slow, arduous process. Regardless of Congress’ intentions, we likely won’t see any materials changes to the tax code during the next year, or even during the tenure of President Trump.


However, City National Rochdale feels that corporations, wealthy individuals and upper-middle class people may receive substantial tax relief in the form of lower marginal tax rates. Corporations will likely experience the greatest amount of tax reduction. The top federal marginal corporate tax rate is currently 35%; the GOP is proposing a top marginal rate of 20%, and Trump is supporting a 15% top marginal rate6.


For individuals, President Trump is proposing a top marginal tax rate of 33%, while congressional Republicans typically favor a top rate of 35% (the current rate is 39.6%)7. In regards to the capital gains tax and the estate tax, both Trump and the Republicans have advocated for the absolute repeal of these measures. Upper- and upper-middle class individuals will find these tax cuts to be advantageous to their bottom line.


With significantly lower tax rates, the national deficit could rise substantially over the next several years. However, if these tax breaks serve as a catalyst for companies and individuals to start spending more, the economy could boom – which could result in a long-term reduction in the deficit.




The attitudes of consumers also play a vital role in shaping the economy. When consumers feel confident about their financial situation, they are inclined to spend more and invest more.


Today, consumer attitudes are positive as a result of various factors. First, the U.S. is the wealthiest country in the world, and we have never held as much wealth as we do today. American households have an estimated $91 trillion of wealth, up from the previous high of $81 trillion in 20078.


Secondly, wages and median household income are on the rise for the first time since 20079. Higher wages for lower- and middle-class consumers help to stimulate the economy.  As businesses receive lower tax rates and have more money to spend, we could see this trend continue.


Thirdly, as mentioned earlier, low levels of unemployment and consumer debt also play an important role in shaping positive attitudes about economic performance.


Lastly, when consumers are anticipating lower tax rates, they will be apt to put their tax savings to work – either by spending or investing the surplus. Increased spending and investment both serve to stimulate the economy.


On the other hand, uncertainty about complex situations can reduce consumer confidence. Because of the uncertainty involved with a major governmental transition – particularly given Trump’s reputation of being unpredictable – some emotion-based investors will react too aggressively. This attitude of uncertainty may bring more volatility to the market, but may not affect the long-term trend of steady economic growth.


When taken as a whole, the current public opinion regarding the U.S. economy could spur increased spending from consumers. The increase in our collective purchasing power may stimulate economic growth in 2017.




Regulations on the private sector are a balancing act. While too few regulations can lead to volatility, overbearing regulations can hinder investment in our economy. Congressional Republicans want to loosen regulations, whereas President Trump has voiced support for eliminating most regulations. Despite this fundamental difference in opinion, the end goal is consistent: reducing regulations on business owners and corporations.


In particular, banking regulations have created a bottleneck in our nation’s financial system since the recession of 2008. In fact, there is more than $3 trillion in corporate and personal assets that are “frozen” in money market funds under the current system10. By loosening regulations, consumers and companies alike may begin to spend and invest this frozen money.


Under the regulatory and tax environment that have existed since 2008, corporate earnings have increased by 4-5% annually11. The new administration’s proposals to deregulate private enterprise and reduce corporate taxes may have a drastically positive impact on corporate earnings.




On trade issues, President Trump breaks from the mainline Republicans in Congress. While most Republicans have supported free trade agreements and globalist policies, President Trump has been outspoken in supporting domestic manufacturing and economic protectionism.


Trump’s call for tariffs – or “border adjustment fees” – could lead to an increase in prices for consumers. Levying a 20% tax on all imports from Mexico and China may incentivize consumers to buy more American-made goods; however, the actual burden of the tariff falls on consumers, who would have to pay 20% more for some of the goods they need.


Also, other countries could retaliate if we begin to levy tariffs against their products – sparking a trade war. In the case of China, retaliation of tariffs could be dangerous for the U.S. economy. China owns a significant portion of our national debt and produces a substantial amount of our consumer goods. The risks associated with tariffs against China and Mexico far outweigh the potential benefits for U.S. manufacturing.


When considering trade, the 80/20 rule (otherwise known as the Pareto rule) can be instructive. While the 20% of Americans who are involved in manufacturing benefit from protectionist policies and a weak U.S. dollar, about 80% of our population benefits from free trade and a strong U.S. dollar. In short, free and fair trade policies that embrace globalization lead to a positive impact on our economy.




The first four factors of START – stimulus, taxes, attitude and regulation – are positive indicators for economic growth under the Trump administration. On the other hand, protectionist trade policies could be a wild card that lead to volatility in the market.


Overall, 2017 should be an interesting year for investors.





1) Congressional Budget Office 2016 Year-End Report
2) Word Bank Annual GDP Growth Rate by Country, 1961-2015
3) Bureau of Labor Statistics Consumer Spending Report, Year-End 2014
4) Bureau of Labor Statistics Jobs Report, Q4 2016
5) Federal Reserve Consumer Debt Report, Q3 2016
6-7) Congressional Budget Office & Tax Policy Institute, 2016
8) US Department of the Treasury: Financial Crisis Response Report, 2015
9) Bureau of Labor Statistics Jobs Report, Q4 2016
10) A Financial History of the United States: From the Enron-Era Scandals to the Great Recession (Markham, J.W.), 2015
11) U.S. Bureau of Economic Analysis: U.S. Corporate Profits, 1951-2016


This newsletter is an independently created publication which is meant for the general illustration and/or informational purposes only. Although this information has been gathered from sources believed to be reliable, it cannot be guaranteed. The views expressed are not necessarily the opinion of FSC Securities Corporation and should not be construed directly or indirectly, as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets, opinions are subject to change without notice. All Investing involves risk including the potential loss of principal. No investment strategy including buy and hold and diversification can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary and therefore information presented here should only be relied upon when coordinated with professional advice. This information is not to be taken as investment advice or a guarantee of future results.

2016 in Review – An Economic Update

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You know you’re deep into a longstanding bull market when you see things like average pedestrians keeping one eye on the market tickers outside of brokerage houses to see when the Dow Jones Industrial Average has finally breached the 20,000 mark.  Who would have imagined record market highs at this point last year, when the indices ended the year in negative territory?  Or when 2016 got off to such a rocky start, tumbling 10% in the first two weeks—the worst start to a year since 1930?


The markets eventually bottomed in mid-February and began a long, slow recovery, turning positive by the end of March, suffering a setback when the U.K. decided to leave the Eurozone and endured another hard bump right after the elections.  In the end, we were disappointed; the Dow finished at 19,762.60 for the year—by the bull market has continued for another year.


This was the second year in a row that the final quarter provided investors with solid gains. The Wilshire 5000–the broadest measure of U.S. stocks—was up 4.54% in the fourth quarter of 2016, ending the year up 13.37%.  The comparable Russell 3000 index gained 4.21% in the final quarter, to finish up 12.74% for the year.


Large cap stocks were up as well.  The Wilshire U.S. Large Cap index gained 4.14% in the fourth quarter, and finished the year up 12.49%.  The Russell 1000 large-cap index closed with a 3.83% fourth quarter performance, and finished the year up 12.05%, while the widely-quoted S&P 500 index of large company stocks was up 3.25% in the fourth quarter, finishing up 9.54% for calendar 2016.


The Wilshire U.S. Mid-Cap index gained 5.31% in the final quarter, finishing the year with a gain of 17.22%.  The Russell Midcap Index gained 3.21% in the fourth quarter, and was up 13.80% in calendar 2016.


This was a year to remember for investors in small company stocks.  As measured by the Wilshire U.S. Small-Cap index, investors posted an 8.30% gain over the last three months of the year, for a total return of 22.41% over the entire 12 months.  The comparable Russell 2000 Small-Cap Index finished the year up 21.31%, while the technology-heavy Nasdaq Composite Index rose 1.34% in the fourth quarter, to finish the year up 7.50%.


International investments contributed a slight decline to overall portfolio returns.   The broad-based EAFE index of companies in developed foreign economies lost 1.04% in the fourth quarter of the year, finishing the year down 1.88% in dollar terms.  In aggregate, European stocks lost 3.39% for the year, while EAFE’s Far East Index gained just 0.14%.  Emerging markets stocks of less developed countries, as represented by the EAFE EM index, gained 8.58% for the year.


Looking over the other investment categories, real estate investments, as measured by the Wilshire U.S. REIT index, lost 2.28% during the year’s final quarter, but managed to finish up 7.24% for calendar 2016.


Last year, investors were wondering why they owned commodities in their portfolios, when their statements showed that the index delivered a whopping 32.86% loss.  This year, they may be wondering why they weren’t more committed to the asset class, as the S&P GSCI index gained 27.77%, fueled in part by a 45.03% rise in the S&P crude oil index.  Gold prices shot up 8.63% for the year and silver gained 15.84%.


In the bond markets, it’s possible that the decades-long bull market—which basically means declining interest rates—has ended, and the fixed-income world is experiencing rate rises.  But despite the nudge by the Federal Reserve Board, the moves have not exactly been dramatic.  Over the past year, rates on 10-year Treasury bonds have risen from 2.25% to 2.44%, while 30-year government bond yields have risen from 3.00% to 3.07%.  According to Barclay’s Bank indices, U.S. liquid corporate bonds with a 1-5 year maturity have seen yields rise incrementally from 2.4% to 2.8% on average.


As always, there were many unpredictable anomalies in the investment world.  In the international markets, anyone lucky enough to have speculated on the Brazilian Bovespa index—comparable to the U.S. S&P 500—would have reaped a gain of 68.9% this year, despite all the headline drama around the Zika virus and political uncertainties that were reported on during the Olympic games.  Russian stocks were up 51% for the year, despite the recent sanctions from the U.S. government and the lingering international sanctions related to the invasion of the Crimean peninsula.


What’s going to happen in 2017?  Short-term market traders seem to be expecting a robust economic stimulus combined with lower taxes and deregulatory policies that would boost the short-term profits of American corporations.  But it is helpful to remember that we are entering the ninth year of economic expansion, making this the fourth longest since 1900.  In addition, growth has not exactly been robust; the U.S. GDP has averaged just 2.1% yearly increases since the Great Recession, making this the most sluggish of all post-World War II expansions.


Slow but steady has not been a terrible formula for workers or stock investors.  The unemployment rate has slowly ticked down from a post-recession peak of 10% to less than 5% currently.  U.S. stock indices are posting record highs with double-digit gains, and that Dow 20,000 level, while essentially meaningless, is still catching a lot of attention.


It’s clear that the new President-elect wants to accelerate America’s economic growth, but the policy prescription has not always been clear.  Will we rip up longstanding trade agreements, cut back on immigration quotas and deport millions of workers who crossed the border without a visa?  Will there be a wall built between the U.S. and Mexico?  Will the government pay for huge infrastructure projects, at the same time reducing taxes and thus raising the national debt?  Will Congress raise the debt ceiling without protest if that happens?  Will the Fed raise rates more aggressively in the coming year, or cooperate with the President-elect in his efforts to drive the economy into a faster lane?


At the same time, there are many unknowns around the globe.  China’s economic growth has stalled for the second consecutive year, and you will soon be reading about a banking crisis in Italy that could force the country to leave the Eurozone—potentially a much bigger blow to European economic unity than Brexit or a still-possible Greek exit.  Russian hackers may have ushered in an era of unfettered global intrusions into our Internet infrastructure, and there will surely be a continuation of ISIS-sponsored terrorism in Europe and elsewhere.


Every year of this longstanding bull market, we have to look over our shoulders and wonder when and how it will end.  With the January downturn and so much uncertainty at this time last year, nobody could have predicted double-digit returns on U.S. stocks at year-end.  Next year could bring more of the same, or it could fulfill the dire predictions many have made during the election cycle, including both Democrats and Republicans who believe the country is in worse shape than the numbers would indicate.


What we have learned over the past few years is that the markets have a way of surprising us, and that trying to time the market, and get out in anticipation of a downturn, is a loser’s game.  At the county fair, when we get on the roller coaster, we don’t bail out and jump over the side at some scary point on the track; we hang on for the ride.  The history of the markets has been a general upward trend that benefits long-term investors, and looking out over the long-term, that—and a few hard bumps along the way–is probably the best outcome to expect.



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

Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp

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

Nasdaq index data:



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/

Aggregate corporate bond rates:


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

Muni rates:  https://indices.barcap.com/show?url=Benchmark_Indices/Aggregate/Bond_Indices





Federal Reserve Interest Rate Hike

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Was anybody surprised that the Federal Reserve Board decided to raise its benchmark interest rate last week?

The U.S. economy is humming along, the stock market is booming and the unemployment rate has fallen faster than anybody expected. The incoming administration has promised lower taxes and a stimulatory $550 billion infrastructure investment. The question on the minds of most observers is: what were they waiting for?


The rate rise is extremely conservative: up 0.25%, to a range from 0.50% to 0.75% – which, as you can see from the chart, is just a blip compared to where the Fed had its rates ten years ago.



The bigger news is the announced intention to raise rates three times next year and to move rates to a “normal” 3% by the end of 2019—which is faster than some anticipated, although still somewhat conservative. Whether any of that will happen is unknown; after all, in December 2015, the Fed was telegraphing two and possibly three rate adjustments in 2016, before backing off until now.


The rise in rates is good news for those who believe that the Fed has intruded on normal market forces by suppressing interest rates much longer than could be considered prudent, and even better news for people who are bullish about the U.S. economy.


The Fed may have been the last remaining skeptic that the U.S. was out of the danger zone of falling back into recession; indeed, its announcement acknowledged the sustainable growth in economic activity and low unemployment as positive signs for the future.


However, bond investors might be less pleased, as higher bond rates mean that existing bonds lose value. The recent rise in bond rates at least hints that the long bull market in fixed-rate securities—that is, declining yields on bonds—may finally be over.


For stocks, the impact is more nuanced. Bonds and other interest-bearing securities compete with stocks in the sense that they offer stable—if historically lower—returns on your investment. As interest rates rise, the see-saw between whether you prefer stability or future growth tips a bit, and some stock investors move some of their investments into bonds, reducing demand for stocks and potentially lowering future returns.


None of that, alas, can be predicted in advance, and the fact that the Fed has finally admitted that the economy is capable of surviving higher rates should be good news for people who are investing in the companies that make up the economy.


The Bottom Line

There is no reason to change your investment plan as a result of a 0.25% change in a rate that the Fed charges banks when they borrow funds overnight. There is always too much uncertainty about the future to make accurate predictions, and today, with the incoming administration, the tax proposals, the fiscal stimulation, and the real and proposed shifts in interest rates, the uncertainty level may be higher than usual.

How will the election impact your portfolio?

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By now, most voters have made up their mind about who they want to serve as their next President. But what can they look forward to, from an investment and tax standpoint, if their candidate wins or loses? How will the election affect their portfolio and future net worth?


Let’s look at the least predictable factor. An analysis of historical market returns under different administrations gives a frustratingly incomplete picture.


When a President comes into office and immediately enjoys a few boom years, is that due to his great policies or the policies of his predecessor? Similarly, when a President enters office in the middle of a recession (think Obama in 2009 and George W. Bush in 2001), can we attribute the weak market performance to any policies he hasn’t had a chance to enact?


The cliche that Republicans are better for markets than Democrats is hard to support based on the raw statistics. As you can see from the chart, Richard Nixon and George W. Bush are the only presidents who presided over a net loss in the markets, while Bill Clinton and Barack Obama are second and third behind Gerald Ford as the presidents associated with the highest total gains.




The record is too mixed, and too complicated, to make predictions based simply on the party that wins the white house.


But what about something more concrete, like tax policy or budget deficits? Surely here we can read the tea leaves about the future.


Once again, the historical record can be misleading. President Reagan, known as a great tax cutter, lowered taxes with the 1981 tax act and promptly raised them again with new measures a year later. Democratic President Bill Clinton’s administration presided over the only budget surpluses of the modern era, while Republican President George Bush and Democratic President Barack Obama added more to the deficit than all previous presidents.




The most reliable clue we have about the fiscal and investment impact of a Donald Trump or Hillary Clinton presidency is the actual proposals by the candidates. But even here, we have to proceed with caution. It is unlikely that the Democrats will win the Presidency plus a majority in both the Senate and the House of Representatives, which means that a Clinton wish list will be either stymied or compromised by divided government.


Nevertheless, if Clinton is elected, we know to expect certain changes to the tax code. There will be at least an attempt to add a 4% surtax on incomes above $5 million, an end to the carried interest deduction favored by hedge fund managers and other Wall Street executives, plus a cap on itemized deductions when people reach the 28% tax rate.


In addition, the existing $5.45 million estate tax exemption would be reduced to $3.5 million ($7 million for couples), and estate amounts above that figure would be taxed at a 45% rate. Wall Street brokers would be hit with an unspecified surtax on high-frequency trading activities.


A President Trump would be more likely to get his wishes, but his exact wishes are far less certain. You can get a picture of the fuzziness of his policy proposals when you look at his promise of infrastructure spending.


When Clinton proposed spending $275 billion on road, airport and electrical grid repairs (surely not enough to move the needle on U.S. GDP growth), Trump immediately proposed spending $550 billion on the infrastructure—doubling his opponent’s figure without any apparent analysis.


Many of the proposals have been made off-the-cuff and some are contradictory, but you can expect a President Trump to make an effort to cut taxes by reducing the ordinary income tax brackets to 12% (up to $75,000 for joint filers), 25% ($75,000 to $225,000) and 33% (above $225,000).


Under Trump, the standard deduction would double, but itemized deductions would be capped at $100,000 for single filers ($200,000 for joint filers). Corporate tax rates would be reduced from a maximum of 35% to a maximum of 15%. Federal estate and gift taxes would be eliminated, but the step-up in basis would also be eliminated for estates over $10 million.


Lumping together Clinton and Trump’s various proposals (and making a variety of assumptions to cover the fact that the Trump plan is light on details), the Tax Foundation estimates that the Clinton proposals, in the unlikely event that they were fully-enacted, would reduce GDP by 1% a year and reduce the budget deficit by $498 billion. Candidate Trump’s proposals would reduce tax revenues by between $4.4 trillion and $5.9 trillion over the next decade, but the Tax Foundation believes they would add 6.9% to GDP.


Turning back to the markets, the investment herd prefers certainty and status quo to uncertainty and rapid change. A Clinton presidency checked by either the Republican House or a Republican House and Senate would provide a measure of stability.


A President Trump, with Republicans controlling both houses of Congress, would represent significant uncertainty, and off-the-cuff policy proposals introduced into the news media at random times would likely spook investors. Loose talk about “renegotiating” America’s debt with Treasury bond holders here and abroad (read: default, followed by demanding a haircut) could, all by itself, lower America’s bond rating once again, following the downgrade aftereffect of the government shutdown.




A Clinton presidency would almost certainly have a negative impact on the coal industry, and to the extent that there are new environmental regulations—which can be imposed by regulation without consulting Congress—it could also negatively impact the energy sector overall. It would not be surprising to see a carbon trading initiative, and more broadly a requirement that whatever environmental degradation companies impose on society will have to be paid for by the companies themselves in some form or fashion.


A Trump presidency would seem to favor industry in a variety of ways. The proposals are frustratingly unspecific, but we could expect less regulation (particularly environmental regulation), no raising of the minimum wage, lower corporate taxes across the board and protectionism.


On the other hand, if candidate Trump is serious about deporting undocumented immigrants, the U.S. labor supply would diminish in unpredictable ways. The policy would likely have the biggest negative impact on the farming and construction industries.


Perhaps the biggest risk in this election involves trade. A Trump Presidency would be seen, initially, at least, as a drag on the Mexican markets, and it might see America rip up its trade agreements and pick currency and trade wars with the emerging economic colossus that is China.


Interestingly, the Trans-Pacific Partnership agreement, which both candidates now reject, was an effort by the U.S. to create economic ties to Singapore, Korea, Vietnam and other countries in the Asian rim, the better to counter Chinese economic influence. In terms of global trade, China stands to win no matter who wins this election.


The bottom line: prepare for the possibility (but not the certainty due to gridlock) of higher taxes under a Hillary Clinton presidency, and a more certain (but hard to predict the details) lower-tax environment under a President Trump.


If you’re a Wall Street trader, you’re going to lose money under a Clinton presidency, and Southeast Asian nations stand to lose expected trade benefits under either president.


Despite the usual stereotypes, the deficit would likely go up under a Trump presidency and it might go down under a Clinton one — again with the caveat that comes with a divided government. The economic outlook would be much harder to predict.


The reality is that no matter who wins, America will still represent the most dynamic economy in the world, and whoever wins the White House is unlikely to change that.



U.S. Federal Debt by President / Political Party



2016 Third Quarter Economic Update

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One hundred days after the Brexit scare – and three-quarters of a year after the most recent Fed rate hike – the markets once again confounded the instincts of nervous investors and went up instead of down. Last week, Fed Chairperson Janet Yellen told the world that the U.S. economy is healthy enough to weather a rise in interest rates, but the Fed governors met in September and declined to serve up the first rate hike since December 15. That was reassuring news to the Wall Street traders, and investors generally, helping to provide yet another quarter of positive gains in U.S. stocks.


The Wilshire 5000 Total Market Index – the broadest measure of U.S. equities – gained 4.53% for the third quarter, and is now up 8.39% for the first three quarters of the year. The comparable Russell 3000 index was up 4.40% for the quarter and is sitting on 8.18% gains so far this year.


Larger companies posted the lowest gains. The Wilshire U.S. Large Cap index was up 3.92% in the third quarter of 2016, putting it at a positive 8.01% since the beginning of January. The Russell 1000 Large-Cap index provided a 4.03% return over the past quarter, with a gain of 7.92% so far this year, while the widely-quoted S&P 500 index of large company stocks posted a gain of 3.31% in the third quarter, and is up 6.08% for the year so far.


Meanwhile, the Wilshire U.S. Mid-Cap index was up 4.35% for the quarter, and is sitting on a positive gain of 11.31% for the year. The comparable Russell Midcap Index gained 4.52% for the quarter, and is up 10.26% for the year.


Small company stocks, as measured by the Wilshire U.S. Small-Cap index, gave investors a 7.67% return during the third quarter, up 13.03% so far this year. The comparable Russell 2000 Small-Cap Index gained 9.05%, posting an 11.46% gain so far this year, while the technology-heavy NASDAQ Composite Index gained 9.67% for the quarter and is up 6.06% heading into the final quarter of 2016.


Looking abroad, the U.S. remains a haven of stability in a messy global investment scene. The broad-based EAFE index of companies in developed foreign economies gained 5.80% in dollar terms in the third quarter of the year, but is still down 0.85% for the first three-quarters of the year. In aggregate, European stocks have lost 2.67% so far in 2016. Far Eastern stocks are up just 1.73% for the year. In contrast, a basket of emerging markets stocks domiciled less developed countries, as represented by the EAFE EM index, gained 8.32% for the quarter, and are sitting on gains of 13.77% for the year so far.


Looking over the other investment categories, real estate investments, as measured by the Wilshire U.S. REIT index, were down 1.21% for the second quarter, but still enjoy a gain of 9.75% for the year. Commodities, as measured by the S&P GSCI index, lost 4.15% of their value in the third quarter, but are sitting on gains of 5.30% for the year so far.


On the bond side, the interest rate story is essentially unchanged: rates are still low, once again confounding all the experts who have been expecting significant rate rises for more than half a decade. Ten-year U.S. government bonds are currently yielding 1.59%. Three-month notes were yielding 0.27% at the end of the quarter, while 12-month bonds were paying just 0.58%. Go out to 30 years, and you can get a 2.32% annual coupon yield.


What’s keeping stock prices high while sentiment appears to be “restrained”? Nobody knows the answer, but a deeper look at the U.S. economy suggests that the economic picture isn’t nearly as gloomy as it is sometimes reported in the press. Economic growth for the second quarter has been revised upwards from 1.1% to 1.4%, due to higher corporate spending in general and especially as a result of increasing corporate investments in research and development. America’s trade deficit shrank in August. Consumer spending – which makes up more than two-thirds of U.S. economic activity – rose a robust 4.3% for the quarter, perhaps partly due to higher take-home wages this year.


Meanwhile, if someone had told you five years ago that today’s unemployment rate would be 4.9%, you would have thought they were highly optimistic. But after the economy gained 151,000 more jobs in August, unemployment remained below 5% for the third consecutive month, continuing the downward trend. At the same time, average hourly earnings for American workers have risen 2.4% so far this year.


Based on their reading of the Treasury yield curve, economists at the Federal Reserve Bank of Cleveland have pegged the chances of a recession this time next year at a low 11.25%. They predict GDP growth of 1.5% for this election year—which, while below targets, is comfortably ahead of the negative numbers that would signal an economic downturn. (In general, a steep yield curve has been a predictor of strong economic growth, while an inverted one, where short-term rates are higher than longer-term yields, are associated with a looming recession.)


On top of everything else, corporate profits have been on a long-term upswing, even if the rise has been choppy since 2008. Will this long-term trend continue? Who knows?


The U.S. returns have been so good for so long that many investors are wondering why we are bothering with foreign stocks. A recent Forbes column suggested the answer. Since 1970, foreign stocks have outperformed international stocks almost exactly 50% of the time – meaning the long trend we’ve become accustomed to could reverse itself at any time.


Nobody would dispute that the economic statistics are weak tea leaves for trying to predict the market’s next move, and it is certainly possible that the U.S. and global economy are weaker than they appear. But the slow, steady growth we’ve experienced since 2008 is showing no visible signs of ending, and it’s hard to find the usual euphoria and reckless investing that normally accompanies a market top and subsequent collapse of share prices.


At the current pace, we might look back on 2016 as another pretty good year to be invested, which is really all we ask for.



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

Russell index data: http://indexcalculator.russell.com/

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

NASDAQ index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP

International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html

Commodities index data:


Treasury market rates:


Aggregate corporate bond rates:









Understanding Brexit – How will it impact me?

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Yesterday’s vote by the British electorate to end its membership in the European Union seems to have taken just about everybody by surprise, but the aftermath could not have been more predictable. The uncertainty of how, exactly, Europe and Britain will manage a complex divorce over the coming decade sent global markets reeling.

London’s blue chip index, the Financial Times Stock Exchange 100, lost 4.4% of its value in one day, while Germany’s DAX market lost more than 7%. The British pound sterling is getting crushed (down 14% against the yen, 10% against the dollar).

Compared to the global markets, the reaction among traders on U.S. exchanges seems muted; down roughly 3% as you read this, though nobody knows if that’s the extent of the fall or just the beginning.

The important thing to understand is that the current market disruptions represent an emotional roller coaster, an immediate panic reaction to what is likely to be a very long-term, drawn out, ultimately graceful accommodation between the UK and Europe. German companies are certainly not 7% less valuable today than they were before the vote, and the pound sterling is certainly not suddenly a second-rate currency.

When the dust settles, people will see that this panicky Brexit aftermath was a buying opportunity, rather than a time to sell. People who sell may not realize that panic may be masquerading as an assessment of real damage to the companies they’ve invested in.

What happens next for Britain and its former partners on the continent?  Let’s start with what will NOT happen. Unlike other European nations, Britain will not have to start printing a new currency. When the UK entered the EU, it chose to retain the British pound— that, of course, will continue. Stores and businesses will continue accepting euros.

money-718619_1280On the trade and regulatory side, the actual split is still years away. One of the things you might not be hearing in the breathless coverage in the press is that the British electorate’s vote is actually not legally binding. It will not be until and unless the British government formally notifies the European Union of its intention to leave under Article 50 of the Treaty of Lisbon—known as the “exit clause.”

If that happens, Article 50 sets forth a two-year period of negotiations between the exiting country and the remaining union. Since British Prime Minister David Cameron has officially resigned his post and called for a new election, that clock probably won’t start ticking until the British people decide on their next leader. For the foreseeable future, despite what you read, the UK is still part of the Eurozone.

After notification, attorneys in Whitehall and Brussels would begin negotiating, piece by piece, a new trade relationship, including tariffs, how open the UK borders will be for travel, and a variety of hot button immigration issues. Estimates vary, but nobody seems to think the process will take less than five years to complete, and current arrangements will stay in place until new ones are agreed upon.

An alternative that is being widely discussed is a temporary acceptance of an established model—similar to Norway’s. Norway is not an EU member, but it pays EU dues, and has full access to the single market as if it was a member. However, that would require the British to continue paying EU budget dues and accept free movement of workers—which were exactly the provisions that voters rejected in the referendum.

Meanwhile, since the Brexit vote is not legally binding, it’s possible that the new government might decide to delay invoking Article 50. Or Parliament could instruct the prime minister not to invoke Article 50 until the government has had a chance to study further the implications.  There could even be a second referendum to undo the first.

The important thing for everybody to remember is that the quick-twitch traders and speculators on Wall Street are chasing sentiment, not underlying value, and the markets right now are being driven by emotion to what is perceived as an event, but is really a long process that will be managed by reasonable people who aren’t interested in damaging their nation’s economic fortunes.

Nobody knows exactly how the long-term prospects of Britain, the EU or American companies doing business across the Atlantic will be impacted by Brexit, but it would be unwise to assume the worst so quickly after the vote.

But you can bet that, long-term, everybody will find a way to move past this interesting, unexpected event without suffering—or imposing—too much damage. Meanwhile, the market roller coaster seems to have entered one of those wild rides that we all experience periodically.

Please reach out to your CAS advisor if you would like to discuss in further detail.



The Good Side of Bad Markets

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CA - 2016-2-1 - pictureAfter the recent downturn in the U.S. and global stock markets, you can be pardoned if you wished that the markets were a bit tamer.  Wouldn’t it be nice to get, say, a steady 4% return every year rather than all these ups and downs?

Be careful what you wish for.  There are at least three reasons why you should hope the markets continue scaring investors half out of their wits.

  1. The very fact that stock downturns scare people is one reason why stocks deliver a higher return than bonds.  Economists call it the “risk premium;” which can be roughly translated as: people are not willing to pay as much for an investment that will periodically frighten them to death as they would pay for an investment that delivers a less exciting investment ride.  Over their history, stocks have been a fairly consistent bargain relative to less volatile alternatives, which is another way of saying that they’ve delivered higher long-term returns than bonds and cash.
  2. If you’re accumulating for retirement by putting money in the market every month or quarter, every downturn means that you can buy shares at a bargain price while many other investors are selling out at or near the bottom.   Over time, as the market recovers, this can give a little extra kick to your overall return.
  3. Market downturns give an advantage to those who are willing to practice disciplined rebalancing among different asset classes.  Basically, that means that when stocks go down, any new cash goes disproportionately into stocks to bring them back up to their former share of the overall portfolio.  This, too, allows you to buy extra shares when the prices are low, and can also boost long-term returns.

There’s no question, the downward plunge on the stock market roller coaster is scary.  It’s hard to maintain your discipline when the voice in the back of your brain is telling you to bail out on the bouncy trip before somebody gets hurt.

But unless this is the first time in history that the market goes down and stays down forever, we will ultimately look back on the decline and see a buying opportunity, rather than a great time to sell and jump to the sidelines.  The patient, disciplined, long-term investor should see market volatility as one of your best friends and allies in your journey toward retirement prosperity.

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