’Tis the Season

The period between Thanksgiving and the end-of-year holiday season would seen like a sleepy time for financial planners, but in fact it is anything but.  You might be surprised at how much activity takes place on behalf of you and your investments in the final month of the year.

For instance?  Even though this has been a good year in the markets, not all investments will have gained value.  This is the last opportunity to harvest any losses we find in taxable accounts, by selling investments that have gone down and “booking” the loss.  Then we can look for investments that have gained value, sell some of those to offset the losses, and thereby save capital gains taxes in the future.  Up to $3,000 of ordinary income can be offset by investment losses as well.

This is also the time of year when mutual fund companies post, in advance, the amount of ordinary income and capital gain distributions they will make to their shareholders.  Since the value of the shares drops by the amount that is distributed, this would seem like a non-event performance-wise.  But in fact some mutual funds are poised to make 20% or even 30% distributions, and this cash is immediately taxable, unlike gains in the share values, which are only realized when you decide to sell.  By selling funds before the distributions, and buying them back later, we can reduce your tax bill this year.

For people over age 70 1/2, this is the time to make sure that the required minimum distributions have been made out of IRA accounts, since failing to take that money out of the tax-deferred bucket would result in an IRS penalty.  And of course we keep an eye on the various tax reform proposals, and tentatively plan around them.  One possibility this year is to make charitable contributions before year-end, in case the deductability of your donations goes away.  If we believe tax rates are going down, and especially if itemized deductions are about to be limited, we might consider accelerating expenses into this year and deferring income, where we can, into next year’s lower brackets.

Meanwhile, we hope you enjoy the holiday season, and that you gain a little extra comfort knowing that a lot of issues are being tended on your behalf.

 

Bitcoin Bubble

It is probably not a good sign for an investment when its largest clearing firm takes out an advertisement in the Wall Street Journal asking for more regulatory oversight and warning investors that its investment category is so volatile that futures contracts could create devastating losses.  Yet this is exactly what has happened recently when Interactive Brokers, the clearing firm for the bitcoin cryptocurrency, responded to the Chicago Mercantile Exchange’s plans to start listing bitcoin futures.

The dustup is significant for a variety of reasons.  First, you can hardly turn on your computer today without reading about the remarkable runup in bitcoin prices, and seeing a plethora of advertisements telling you how you, too, can get on the action.  This, of course, is exactly what one sees at a precipitous market top, and indeed bitcoins are now trading at around $7,800—up more than 700% year to date, compared with a mere 14.6% for a pedestrian investment known as the S&P 500 index.

Second, there are serious questions—despite the “come-ons” and advertisements—about whether bitcoins should be considered investments in the first place.  This proposed futures contract is the cryptocurrency’s first foray into the mainstream investment world, and some bitcoin owners are now wondering what, exactly, one does with a “currency” that is nothing more than blips in a distributed computer database, whose primary purchase vectors so far have been illegal drugs and illicit weaponry.

Bitcoin owners, meanwhile, are doubtless experiencing some of the same feelings that a dutch farmer would have gone through in the early 1600s, when the tulip bulb he held in his hand—worth far less than a guilder two years before—could now, in the teeth of a mania, be sold for a nice house or ten times the annual income of a skilled craftsworker.  The wise move then would have been to cash out before the collapse.  The same may be true today.

Sources:

https://www.ft.com/content/b4c1a564-c9fe-11e7-ab18-7a9fb7d6163e

https://www.marketwatch.com/story/wall-street-pioneer-takes-out-ad-in-wsj-to-warn-of-bitcoin-trading-perils-2017-11-15?mod=mw_share_twitter

https://www.forbes.com/sites/cbovaird/2017/11/16/bitcoin-reaches-latest-high-inches-closer-to-8000/#1fc43ef74caa

https://www.economist.com/blogs/buttonwood/2017/11/greater-fool-theory-0?fsrc=scn/tw/te/bl/ed/?fsrc=scn/tw/te/bl/ed/thebitcoinbubblegreaterfooltheory

 

Bear Warning

One of the oddities of a significant bull market—and this one we’re in today qualifies, as the second-longest in modern American history—is that they tend to go on longer than you might expect from the pure market fundamentals.  The last leg of a bull market tends to be driven by psychology; people have recently experienced an up market, and so they tend to expect more of the same.  They buy at prices they would never consider buying at when the markets have experienced a downturn, driving prices ever higher without regard to the price.  As a result, the long tail of the bull market will also see some of the greatest, fastest increases.

Whenever stocks become more expensive than their long-term averages, we enter a time of when a market downturn should not be a surprise.  Today, as you can see from the accompanying charts, The S&P 500 index is moving into rare valuation territory.  The first chart shows the evolution of the total market capitalization of the S&P 500 compared with U.S. gross domestic product.  The second shows the Shiller CAPE price/earnings ratio—a popular measure of stock market valuations.  In both cases, you can see that buying company earnings has actually become more expensive than it was before the Great Recession, and may be approaching the rarified territory of the dot-com bubble.

Of course, we have no way of knowing whether the next year will bring us more good news or the long-awaited downturn of 20% or more (the definition of a bear market).  Other than market valuations, the signs are positive.  American corporations continue to report strong earnings, economic expansion continues steadily albeit more slowly than historical norms, and a greater number of countries are experiencing sunny economic weather.  Persistently low interest rates mean that investment dollars virtually have to turn to the stock market for the potential to earn reasonable returns.  And, as mentioned before, the end of a bull market tends to be very generous to patient investors.

The key point to remember is that investment markets are, by their nature, volatile and unpredictable.  Historically, the market has experienced a 5% correction every 7.2 months and a 10% correction every 26.1 months.  We know that a more precipitous bear market (defined as a drop of 20% or more) is in our future, but we have no idea when or how.  We do not practice market timing because we believe that long-term investment success comes from patience. When you jump out of the market to avoid a downturn, there is no way to make up for the returns you lost while you were on the sidelines.  All we know for sure is that the next correction will represent an opportunity to rebalance and buy positions more cheaply than today’s prices—and, if the past is any indication, to sell higher down the road.

Here’s a prediction we can all be confident in: over the next few months or years, you will read financial headlines that say the bull market has a long way to run, and others that will say a devastating bear run is imminent.  Please remember that nobody has a magic crystal ball.  The more important thing to remember is that markets in the past have experienced terrible losses, only to experience new highs a few years later.

 

Ancient Adult Beverages

People have been drinking alcoholic beverages for a very long time.  Recently, a team of researchers found evidence of large-scale wine making in 6,000 BC—in clay vats big enough to hold 400 bottles of wine, in the Caucasus mountains in the modern nation of Georgia.  The grapes came from vitis vinifera, the only grapevine species known to have been domesticated, and the grandparent of all 8,000-10,000 modern wine-making grape species.

This is the first evidence of large-scale production, but not the earliest archeological evidence of adult beverages.  Traces of a concoction made from wild grapes, hawthorn fruit, rice beer and honey mead have been found on pottery from China that dates to around 7,000 BC.

More recently—as in, in the past few years—Patrick McGovern of the Biomolecular Archaeology Project for Cuisine, Fermented Beverages, and Health at the University of Pennsylvania Museum has been recreating ancient beverages.  Among them: an ancient ale made with cacao, dated to 1400 B.C. in Honduras,  and early Etruscan based on residues found in 2,800-year-old tombs in central Italy.  The Etruscans used malted heirloom barley and wheat, mixed with hazelnut flour, pomegranate and myrrh.

One of the most interesting is the Midas beverage, made in bronze vessels recovered from the Midas tomb in Turkey, which dates from 700 B.C. The ingredients included wine, barley beer, and mead.  By adding some saffron as a bittering agent (hops were not available in the Middle East 2,700 years ago) the researchers produced a sweet, aromatic blend which Dr. McGovern describes as a little like white wine, with delicious, piquant qualities.

But Dr. McGovern points out that ancient beverages probably varied dramatically from one batch to the next.  Different “vintages” would have been made up of whatever ingredients happened to be available, which means the alcohol manufacturers alternated between beer and mead along with wine, and sometimes producing mixtures of all of the above.

Sources:

https://www.economist.com/news/science-and-technology/21731456-viticulture-was-big-business-ancient-caucasus-wine-making-existed-least?fsrc=scn/tw/te/bl/ed/

http://www.slate.com/articles/health_and_science/medical_examiner/2017/11/mixing_opioids_with_other_drugs_makes_them_particularly_risky.html

Multiplying Disasters

Does it seem to you that America is experiencing more than its share of natural disasters, and that there are more extreme weather events happening today than ever before?  Turns out you’re right.  Since 1970, the number of major storms, floods, earthquakes and heatwaves that cause at least ten deaths or prompt the declaration of a national emergency has quadrupled worldwide, to around 400 a year.  China, India and America suffer the greatest number of natural disasters—not always in that order.

The accompanying chart only goes up to the unusually mild year of 2011, and therefore misses the increases over the last few years, but you can see the trend, and it’s an ominous one.  But if you look away from the blue line, listing the number of disasters, to the orange one, listing the number of deaths, the situation becomes more hopeful.  Due to better preparedness, better home and building construction and more prompt relief efforts, disasters that would have caused many deaths in the early 1900s cause proportionately fewer today.

An article in The Economist warns against complacency, however.  Urban planners, it says, have to operate on the assumption of even more extreme events.  Today, it appears, the storms and other disasters are delivering a high social cost even before they strike.

Source:

https://www.economist.com/blogs/graphicdetail/2017/08/daily-chart-19

 

Savings Rates Decline

You don’t hear much about America’s personal savings rate these days, and the reason may be because the news is discouraging: collectively, the percentage of our income that we save is trending downward again, and may be about to hit record lows.  The Federal Reserve Bank of St. Louis tracks the U.S. personal savings rate, going back to the late 1950s, when when people were setting aside a thrifty 11% of what they made.  Americans achieved a record 17% savings rate in the mid-1970s (see chart) before a long decline set in.  In 2013, the rate briefly spiked again above 10%, but as you can see from the chart, Americans have become less thrifty since then.  The most recent data point shows Americans saving just 3.6% of their income.

How does this compare to the rest of the world?  A chart on the Trading Economics website shows that most countries fall in the 4.5% to 10% range, but with considerable fluctuation.  For instance, Spain experienced a negative savings rate just last quarter, but this quarter reports a rate of more than 14%.  Japan and Mexico seem to be consistently the thriftiest of the reporting nations, each with savings rates above 20%.  (India’s rate on the chart appears to be in error.)

Does any of this matter?  Economists will tell you that when the savings rate is high, it cuts into consumption, which lowers economic activity.  But at the same time, countries with high savings rates have more capital to invest in their future, and their citizens tend to be less vulnerable to economic downturns.  On the whole, we should probably prefer more savings to less.

Sources:

 

https://tradingeconomics.com/united-states/personal-savings

 

https://fred.stlouisfed.org/series/PSAVERT

 

The New Tax Legislation

Chances are, you’ve heard that tax “reform” is right around the corner—that is, if you can call it “reform” when hundreds or perhaps thousands of new pages are about to be added to the tax code.  First, the White House released its tax legislation wish list.  Now the Republicans in the House of Representatives have released a proposal called the “Tax Cuts and Jobs Act,” which fleshes out some of the details.

The House bill would reduce the number of tax brackets from seven currently (10%, 15%, 25%, 28%, 33%, 35% and 39.6%) to four: 12% (up to $45,000 income for singles; $90,000 for joint filers), 25% ($200,000 single; $260,000 joint), 35% (over $500,000 for singles; $1 million joint) and 39.6% (above $1 million for single filers; $1.2 million joint).  The impact on any individual is complicated; people who are currently in the 15% bracket and the bottom of the 25% bracket would, under the new bill, pay taxes at a lower 12% rate.  People who were previously in the 28% bracket would tumble down into the 25% rate.  But people making between $20,000 and $40,000, and those between $200,000 and $500,000 would actually experience a tax increase as they move into a higher marginal rate.

It gets more complicated, because there’s effectively a fifth tax bracket that nobody is talking about, perhaps because it only impacts the highest-income Americans. Anybody who thinks tax “reform” is making the system less complicated should ponder how this would be calculated; once a person or couple have income sufficient to reach the top bracket, they would subsequently add on a 6% surtax to the amount over that top bracket threshold until the entire benefit of their 12% rate has been phased out.  In effect, individuals with taxable income between $1 million and $1.207 million, or joint filers with taxable income between $1.2 million and $1.614 million, would face a special 45.6% tax bracket.  After that, they revert back to the 39.6% rate.  This is simplification?

The dreaded alternative minimum tax would be eliminated under the new bill; however,  the AMT credit carryforwards would still be deductible.  The bill would continue the current capital gains rate structure of 0% (for those with up to $51,700 individual/$77,200 joint in taxable income), 15% (up to $425,800 individual/$479,000 joint) and a 20% rate for those in the top tax bracket.  The 3.8% Medicare surtax on net investment income (which includes capital gains and dividend income) would be retained, and be added onto the 15% and 20% capital gains rates.  So the actual capital gains rates would be 15%, 18.8% and 23.8%.

Meanwhile, the personal deduction and standard deduction would be combined into an expanded standard deduction of $12,000 for individuals, $24,000 for joint filers. Some families with more than three children would lose benefits under this proposal, since their personal deductions under the old system would have exceeded the expanded standard deduction in the newly proposed one.  A higher standard deduction, by itself, would reduce the number of people claiming itemized deductions, but in addition, the bill would greatly reduce the list of qualified deductions, reducing the number of itemizers even more.  Under the new proposal, people would no longer be able to deduct any state or local income taxes paid, but they WOULD be able to deduct local real property taxes (like a home and/or a vacation home) up to a maximum of $10,000 a year.  The mortgage interest deduction would be limited to debt on the first $500,000 of a home mortgage (down from $1 million today).

Miscellaneous deductions like the electric drive motor vehicle credit, the adoption tax credit and the credit for moving expenses to a new job would all be eliminated.

Corporate tax rates would be lowered dramatically.  The C-corporation (which is publicly traded companies) would see a maximum 20% tax rate, while pass-through companies like S corporations, partnerships and LLCs would be subject to a maximum rate of 25%–with some very complicated provisions designed to keep their owners from shifting personal income into and through the company to take advantage of potentially lower rates.

Finally, for the very few people who pay estate taxes, the good news is that the exemption limit, currently $5.6 million, would double to $11.2 million per person, $22.4 million for married couples—and the estate tax, according to the language of the bill, would be eliminated altogether in 2024. Gift tax limits would also go up to the exemption amounts.

Would any of this affect your tax bill in 2017?  No.  The provisions, if enacted, would impact the 2018 tax year.

What are the odds of passage?  Who knows?  The Senate is reported to have its own ideas about tax “reform.”

 

Sources:

http://tinyurl.com/yagsu3a6

http://www.philly.com/philly/wires/ap/news/nation/washington/20171103_ap_56e8af4796944f54a5532a36691c5395.html

 

https://www.bloomberg.com/news/articles/2017-11-03/house-tax-cuts-don-t-fully-pay-for-themselves-analysis-finds?cmpid%3D=socialflow-twitter-politics

 

https://www.yahoo.com/finance/news/apos-trump-apos-tax-plan-184700638.html

 

Anti-social Media

Have you ever wondered whether social media was having a positive or negative impact on our mental well-being?  The American Academy of Pediatrics has issued a warning about the negative effects of social media on young kids and teens, and of course it mentions cyber-bullying.  But it notes that the same risks may be true for adults.  The key issues include:

 

1) Addiction.  It’s not clear that there is such a thing as internet or social media addiction, but a review study conducted by researchers at Nottingham Trent University concludes that high participantion in social media is associated with such symptoms as neglect of personal life, mental preoccupation, escapism, mood-modification and a willingness to conceal addictive behavior.

Perhaps more tellingly, when people are asked to stop participating in social media, they seem to undergo a kind of withdrawal.  A study by researchers at Swansea University found measurable psychological and physiological changes in people who are separated from an intense social media habit.

2) Sadness and a lower sense of well-being.  Facebook use has been linked to less moment-to-moment happiness and less life satisfaction, and the more use, the more these symptoms appear to be present.  Researchers believe that frequent Facebook visitors experience social isolation, and that conclusion has now been extended to 11 of the most popular social media sites.

3) Negative comparisons of our lives with the lives of others.  Facebook users seem drawn to compare their lives with the idealized lives that people project with their profiles and pictures—and this can lead to depressive symptoms.

4) Jealousy.  Studies have shown that social media use triggers feelings of jealousy and envy, and you can see why: people make their lives look better than they actually are when they post happy updates or vacation pictures on Facebook and other media sites, and the users who see these posts will be motivated to defend themselves, making jealousy-inducing posts of their own. As they try to compete, they are triggering another round of social jealousy across the network.

The research also found, unsurprisingly, that having more friends on social media doesn’t make you more social; it takes actual social interaction to keep up real friendships.  A virtual friend doesn’t provide the psychological benefits of real friends who are there with you in person.  But you probably knew that already.

Source:

https://www.forbes.com/sites/alicegwalton/2017/06/30/a-run-down-of-social-medias-effects-on-our-mental-health/#45dd0cd22e5a

Tax Reform Proposal

You can be forgiven if you’re skeptical that Congress will be able to completely overhaul our tax system after failing to overhaul our health care system, but professional advisors are studying the newly-released nine-page proposal closely nonetheless.  We only have the bare outlines of what the initial plan might look like before it goes through the Congressional sausage grinder:

We would see the current seven tax brackets for individuals reduced to three — a 12%, rate for lower-income people (up from 10% currently), 25% in the middle and a top bracket of 35%.  The proposal doesn’t include the income cutoffs for the three brackets, but if they end up as suggested in President Trump’s tax plan from the campaign, the 25% rate would start at $75,000 (for married couples), and joint filers would start paying 35% at $225,000 of income.

The dreaded alternative minimum tax, which was created to ensure that upper-income Americans would not be able to finesse away their tax obligations altogether, would be eliminated under the proposal.  But there is a mysterious notation that Congress might impose an additional rate for the highest-income taxpayers, to ensure that wealthier Americans don’t contribute a lower share than they pay today.

The initial proposal would nearly double the standard deduction to $12,000 for individuals and $24,000 for married couples, and increase the child tax credit, now set at $1,000 per child under age 17.  (No actual figure was given.)

At the same time, the new tax plan promises to eliminate many itemized deductions, without telling us which ones other than a promise to keep deductions for home mortgage interest and charitable contributions.  The plan mentions tax benefits that would encourage work, higher education and retirement savings, but gives no details of what might change in these areas.

The most interesting part of the proposal is a full repeal of the estate tax and generation-skipping estate tax, which affects only a small percentage of the population but results in an enormous amount of planning and calculations for those who ARE affected.

The plan would also limit the maximum tax rate for pass-through business entities like partnerships and LLCs to 25%, which might allow high-income business owners to take their gains through the entity rather than as income and avoid the highest personal brackets.

Finally, the tax plan would lower America’s maximum corporate (C-Corp) tax rate from the current 35% to 20%.  To encourage companies to repatriate profits held overseas, the proposal would introduce a 100% exemption for dividends from foreign subsidiaries in which the U.S. parent owns at least a 10% stake, and imposes a one-time “low” (not specified) tax rate on wealth already accumulated overseas.

What are the implications of this bare-bones proposal?  The most obvious, and most remarked-upon, is the drop that many high-income taxpayers would experience, from the current 39.6% top tax rate to 35%.  That, plus the elimination of the estate tax, plus the lowering of the corporate tax (leading to higher dividends) has been described as a huge relief for upper-income American investors, which could fuel the notion that the entire exercise is a big giveaway to large donors.  But the mysterious “surcharge” on wealthier taxpayers might take away what the rest of the plan giveth.

But many Americans with S corporations, LLCs or partnership entities would potentially receive a much greater windfall, if they could choose to pay taxes on their corporate earnings at 25% rather than nearly 40%.  (Note: The Trump organization is a pass-through entity.)

A huge unknown is which deductions would be eliminated in return for the higher standard deduction.  Would the plan eliminate the deduction for state and local taxes, which is especially valuable to people in high-tax states such as New York, New Jersey and California, and in general to higher-income taxpayers who pay state taxes at the highest rate?

Currently, about one-third of the 145 million households filing a tax return — or roughly 48 million filers — claim this deduction.  Among households with income of $100,000 or more, the average deduction for state and local taxes is around $12,300.  Some economists have speculated that people earning between $100,000 and around $300,000 might wind up paying more in taxes under the proposal than they do now.  Taxpayers with incomes above $730,000 would hypothetically see their after-tax income increase an average of 8.5 percent.

Big picture, economists are in the early stages of debating how much the plan might add to America’s soaring $20 trillion national debt.  One back-of-the-envelope estimate by a Washington budget watchdog estimated that the tax cuts might add $5.8 trillion to the debt load over the next 10 years.  According to the Committee for a Responsible Federal Budget analysis, Republican economists has identified about $3.6 trillion in offsetting revenues (mostly an assumption of increased economic growth), so by the most conservative calculation the tax plan would cost the federal deficit somewhere in the $2.2 trillion range over the next decade.

Others, notably the Brookings Tax Policy Center (see graph) see the new proposals actually raising tax revenues for individuals (blue bars), while mostly reducing the flow to Uncle Sam from corporations.

These cost estimates have huge political implications for whether a tax bill will ever be passed.  Under a prior agreement, the Senate can pass tax cuts with a simple majority of 51 votes — avoiding a filibuster that might sink the effort — only if the bill adds no more than $1.5 trillion to the national debt during the next decade.

That means compromise.  To get the impact on the national debt below $1.5 trillion, Congressional Republicans might decide on a smaller cut to the corporate rate, to something closer to 25-28%, while giving typical families a smaller 1-percentage point tax cut.  Under that scenario, multi-national corporations might be able to bring back $1 trillion or more in profit at unusually low tax rates, and most families might see a modest tax cut that will put a few hundred extra bucks in their pockets.

Alternatively, Congress could pass tax cuts of more than $1.5 trillion if the Republicans could flip enough Democratic Senators to get to 60 votes.  The Democrats would almost certainly demand large tax cuts for lower and middle earners, potentially lower taxes on corporations and higher taxes on the wealthy.  Would you bet on that sort of compromise?

Sources:

https://www.yahoo.com/finance/news/trump-overpromising-tax-cuts-205013012.html

The Big Six tax reform framework: Can you dynamically score a question mark?

https://www.washingtonpost.com/blogs/plum-line/wp/2017/09/27/trumps-new-tax-plan-shows-how-unserious-republicans-are-about-governing/?tid=sm_tw&utm_term=.d37e0bcf718d

https://www.yahoo.com/finance/news/hidden-tax-hikes-trumps-tax-cut-plan-202041809.html

https://www.yahoo.com/finance/news/republicans-700-million-problem-could-173027048.html

https://www.yahoo.com/finance/news/trumps-tax-plan-just-got-180000645.html

Economic Progress

 

It’s not uncommon to hear people wish that we could return to the “good old days,” when the world seemed more prosperous.  Of course, depending on how far you go back, the “good old days” might cover a time when the world was poised on the edge of a nuclear precipice, when the Soviet Union and other communist governments basically enslaved more than 50% of the world’s population, when racism was practiced openly and codified in the legal system, when there was no Internet or smartphones, and when TV entertainment consisted of three or sometimes four channels on a heavy, small-screen device that didn’t include a remote.

If you consider our world’s economic history, it actually appears that most of are, today, living in the good old days.  The chart, from the website Our World in Data, shows the change in GDP per capita since 1960—a measure of whether individual countries have increased their overall wealth in the past 54 years.  The dots are individual countries, and if you look at the placement of the dots, you can see the average GDP in 1960 (along the bottom) vs. today (along the left side).  The line moving diagonally across the graph is important; any country whose dot falls above that line has experienced positive GDP growth per citizen.

As you can see, pretty much all the dots are above the line, in many cases far above.  The highest per capita GDP country today is Luxembourg, followed by Singapore, Norway and Switzerland.  The U.S. is on the upper right side of the graph, meaning that it was one of the most prosperous nations in the world in 1960, and still is.

The countries at the bottom of the graph, Central African Republic and Niger, started poor and became more so over the past 54 years.  For them, the “good old days” weren’t so great, but they were better than today.

Source:

https://ourworldindata.org/extreme-poverty/