Higher Rates: Tempest in the Teapot

CA - 2016-12-55 - Fed Funds HikeAnybody who was surprised that the Federal Reserve Board decided to raise its benchmark interest rate this week probably wasn’t paying attention.  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 stimulative $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 accompanying 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 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, suppressed 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 here is that, for all the headlines you might read, 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.







Taxes Up (But Not As Much As You Think)

ca-2016-10-2-taxes-up-deficits-downIf you think taxes are higher than their historical rates, well, it depends on how far back in history you’re comparing them to.  Take a look at the accompanying chart, which shows tax revenue as a percent of total national income for four countries—France, Sweden, the United Kingdom and the U.S.—since 1868.  The chart ends in 2008, and is taken from research by tax policy analyst Thomas Piketty.

People who think taxes are too high will note that today’s total tax haul is much higher today than it had been during the period from 1868 through 1940, and the spike due to World War II’s considerable expenses was never compensated for by a fall back to previous levels.

However, notice that the total for America has largely leveled off in the past 30 years, and most especially notice that the U.S. share of total income, at 27.5%, is considerably lower than the other countries.  Both France and Sweden are flirting with 50% levels, while the U.K. is just above 35%.  In the case of the U.S. and Britain, total tax levels are largely unchanged since around 1960—which is not something you hear in Presidential or Congressional debates about our tax rates.

You also aren’t hearing much about the growing national debt these days, in part because the rate of growth has slowed dramatically and is now at or below historic averages.  The accompanying chart shows an encouraging trend of federal deficit as a percentage of U.S. GDP; the black line represents a zero budget deficit, which was breached briefly during the Bill Clinton presidency.  The dip starting in 2008 represents the historic government bailout which was designed to address the Great Recession and global banking crisis that began in 2008.

Global Debt Overhang

ca-2016-10-15-global-debtYou haven’t heard much about the U.S. government’s debt, in part because, as a percentage of the economy, the growth of our national debt has slowed dramatically.  (See chart)  But measured on a global scale, the world’s $152 trillion of debt—from consumers, corporations and governments worldwide—is more than double the balance at the start of the century, which worries the International Monetary Fund.  That total represents 225% of gross domestic product around the world.

Government debt only accounts for about one-third of the total, and not all countries are contributing their share the total debt burden.  The most recent IMF report singles out China as a country at risk of a disorderly wind-down of high debt levels among its corporations, and shows that emerging market economies, with greater access to credit, are among the fastest-growing global debtors.

Why worry?  The report suggests that high private debt levels can increase the likelihood of a new financial crisis, which can lead to negative economic growth and another debt spiral.  Meanwhile, highly-indebted borrowers are likely to reduce their investment and consumption, dragging down economic growth.

The report doesn’t offer any policy prescriptions, except that the world needs to start digging out slowly and carefully, so as not to trigger a global recession, and in years when the economy is growing, there needs to be a policy that pays down debt—both by governments and the companies and individuals that have a little more money in their pockets.





Gold Up, Gold Down

ca-2016-10-15-gold-up-gold-downThe enduring popularity of gold as an investment has to do with its tangible nature.  Unlike a stock or a bond, you can feel and touch golden coins and larger ingots.  The problem with such tangible assets, of course, is that there is nothing alive about them; that is, there is no claim on the fruits produced by the labor of thousands of workers, in the form of dividends or growth of the enterprise.  As Warren Buffett famously pointed out, if you owned all the world’s gold, you could mainly polish it and admire it in your front yard.

Even so, with all the uncertainty in the Middle East, Brexit and the tumultuous U.S. election, investors piled into gold this year, and have been rewarded with roughly 18% returns so far.  Alas, they are now learning that gold is one of the most volatile of all assets.  Prices have fallen dramatically in the last month, including a 4.5% drop in one week alone.  (see chart)

Experts are saying that if the Federal Reserve Board raises interest rates, that could trigger a further plunge, since investors could park their money in relatively safe investments which (unlike the recent past) paid returns.  Gold was competitive with bonds when bonds (like gold) were paying nothing.  We may be about to see what happens when there’s a difference in yield.





Internet Participation Rates

ca-2016-10-15-internet-participation-rates2Pretty much everybody has access to the Internet.  Don’t they?  The actual global median of all countries is 67% of citizens, but access is not evenly distributed.  In the U.S., 89% of adults use the Internet at least occasionally, according to the Pew Research Center.  Only South Korea (94%), Australia (93%) and Canada (90%) report higher figures, and the UK (88%), Spain (87%), Israel (86%) and Germany (85%) are comparable.

But as you can see from the accompanying chart, Internet access is much lower in places like Ethiopia (just 8% of adults accessing the Internet), Uganda (11%), Pakistan (15%), and even India (22%), Mexico (54%) and China (65%) are surprisingly low.  Russia, at 72%, actually ranks as one of the world’s leaders, although Internet access is not yet ubiquitous as it is in the more developed nations.

The research found, as you might expect, a very strong correlation between country wealth (as measured by per-capita GDP) and internet access.  (See chart)  But a separate part of the study shows that some of the world’s poorer countries are rapidly increasing their internet usage.  In Turkey, Jordan, Malaysia, Chile and Brazil, the percentage of adults using the internet increased by double digits from 2013 to 2015. =

And not surprisingly, the study found that everywhere they looked, younger people age 18-34 were more likely than people over age 35 to say they use the internet or own a smartphone.  Some things are consistent across cultures.

ca-2016-10-15-internet-participation-rates1Source: Pew Research Center’s Global Attitudes Project

Roth Conversions and Mandatory Distributions

You probably know that the IRS requires you to start taking mandatory distributions from your IRA when you turn 70 1/2, even if you don’t actually need the money.  But can you do a Roth conversion at that late date, and thereby defer distributions forever?

The answer is that you CAN do a Roth conversion at any time, including after age 70 1/2.  But that might not be ideal tax planning.  Why?  Because at the time of the conversion, you would have to pay ordinary income taxes on the amount converted—basically, paying Uncle Sam up-front for what you would owe on all future distributions.  So, from a tax standpoint, you’re either paying taxes on yearly distributions or all at once.  (Or, if it’s a partial conversion, on the amount transferred over.)  If the goal was to avoid having to pay taxes on that money until you needed it, the conversion kind of defeats the purpose.

The traditional reason people made Roth conversions was to pay taxes at a lower rate today than the rate they expect to have to pay on distributions in the future.  They might also want to convert in order to leave the Roth IRA dollars to heirs who might be in a higher tax bracket.  But with the new Republican Administration taking over, and Republicans controlling both houses of Congress, tax rates are odds-on favorites to go down, not up, in the near future.

If you still want to go ahead and make a conversion after the mandatory distribution date, the law says that you have to take your mandatory withdrawal from your IRA before you do your conversion.




Uber’s Flying Vision

The future of personal transportation will be very different from the past.  If you marry two clear trends—the advent of self-driving cars with increasingly popular Uber transportation—it’s easy to envision a world where you can sell your car and convert the garage into a spare bedroom.  Why would you need your own auto when you can call for an inexpensive, automated ride to anywhere and back?  And as a bonus, you avoid parking hassles because you’ll be driven right to the destination’s doorstep.

Now let’s marry one more technology to the mix and see what we come up with.  An article in the Economist magazine says that Uber is exploring the use of drone technology.  The company has released a white paper on a program called Elevate, which would involve a fleet of flying cars that could turn a 2-hour road trip into a 15 minute flight at 150 miles an hour.  No traffic, and all trips would take the shortest possible distance.  As a bonus, because there would be no driver and the trips would take less time, the actual cost would be lower than what you pay for a traditional Uber ride today.

The electrically-powered drones would be called VTOLs, or vertical take-off and landing vehicles (see the accompanying picture), which look like modified helicopters.  They would be stationed at “vertiports” when not in use, and periodically return to their port to make use of the charging station.  Then you take a trip, you’ll be delivered to small landing pads on rooftops or parking lots near your destination.

When will this happen?  The white paper anticipates a 10-year period from today’s planning to the launch in 2026.  At that time, it might be possible for people in New York to grab lunch in Philadelphia or Washington, D.C., meanwhile reducing traffic for people who are determined to hang onto their cars.



Retirement Contribution Limits Unchanged

In case you missed it, the contribution limits to your 401(k) plan, IRA and Roth IRA—set by the government each year based on the inflation rate—will not go up in 2017.  Just like this year, you will be able to defer up to $18,000 of your paycheck to your 401(k), and individuals over age 50 will still be able to make a “catch-up” contribution of an additional $6,000.  (The same limits apply to 403(b) plans and the federal government’s new Thrift Savings Plan.)  Your IRA and Roth IRA contributions will continue to max out at $5,500, plus a $1,000 “catch-up” contribution for persons 50 or older.

SEP IRA and Solo 401(k) contribution limits, meanwhile, will go up from $53,000 this year to $54,000 in 2017.

The government has made small changes to the income limits on who can make deductions to a Roth IRA and who can claim a deduction for their contribution to a traditional IRA.  The phaseout schedule for single filers for 2016 starts at $117,000 and contributions are entirely phased out at $132,000; for joint filers the current range is $186,000 to $196,000.  In 2017, the single phaseout will run $1,000 higher, from $118,000 to $133,000, and the joint phaseout threshold will rise $2,000, to $188,000 up to $198,000.  Single persons who have a retirement plan at work will see the income at which they can no longer deduct their IRA contributions go up $1,000 as well, with the phaseout starting at $62,000 and ending at $72,000.  Couples will see their phaseout schedule rise to $99,000 to $119,000.




Balancing Traits

Are you ready to achieve work-life balance?  The American Sociological Review has published a study showing that most of us struggle—which is a fancy word for “fail”—in this important endeavor.  But there’s hope.  The study also found that the minority of people who HAVE managed to achieve some form of the work/life holy grail are doing certain things well.

Like what?  First, they take the time to make deliberate choices about what they want in their lives.  Rather than collapse after work in front of the TV or stay at their desk through their vacation time, they create a road map of the kind of life they want to live, and how they will spend their time, and commit to this path.

Second: they regularly communicate with important people in their lives about what’s working for them, and what isn’t.  This prevents them from drifting off the work-life rails as a result of outside influences and pressures.

Third: they make sure they set aside time for family, friends and their important interests.  Instead of waiting to see if there’s any free time is left over after work, they make a point of booking time off to spend outside of work, and they are willing to guard this time and resist intrusions on it.

Fourth: they develop a strong sense of who they are, and their values, and what’s important to them.  This helps them determine what success means to them, what makes them happy and what they want to get more of in their lives.

Fifth, they are able to tune out distractions, which may mean their electronic devices or just the TV.  This allows them to participate in meditation, enjoy music, engage in physical activity or other things that rejuvenate and regenerate them.

Sixth: They are willing to make sacrifices to get what they want.  They may work extra hard during the week so they can be sure to get the weekend off—or earn an extra day off to add to the planned weekend activity.

Finally: they develop a strong support network that they can depend on to get them through difficult times.  They have a variety of interests, which brings them in contact with like-minded people who will enrich their lives and be there when they’re needed.



Election Impact on your Portfolio

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 cliches 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 Barak 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 together, added more to the deficit than all previous presidents.  (See chart)

The most reliable clue we have about the fiscal and investment impact of a 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 Streeters, plus a cap on itemized deductions when people reach the 28% tax rate.  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 what, exactly, these would be is 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 Candidate Clinton proposed spending $275 billion on road, airport and electrical grid repairs (surely not enough to move the needle on U.S. GDP growth), candidate 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).  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 candidate Clinton and candidate 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 traders, 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