A Word on the New Tax Cuts & Jobs Act

Anthony Christensen

The Tax Cuts and Jobs Act overhauls America’s tax code to deliver what appears to be historic tax relief.  We will stress that it is a really good bill for U.S. companies that do most of their business in the U.S. These companies generally have high tax brackets, such as retailers and banks. It clearly benefits value stocks over growth stocks as the lower tax rates help dividend oriented companies free up earnings that can be used to distribute to stock holders. Below please see a summary of the bill:

• Corporate Rate: The final package lowers the corporate rate to 21% effective January 1, 2018, down from 35%.
• Individual Rates: The final package retains the seven individual rate brackets, but it changes the rates and attachment points. The top rate will be reduced from 39.6% to 37%. These changes would sunset after 2025.
• Significantly increases the Standard Deduction from $6,500 and $13,000 under previous law to $12,000 and $24,000 for individuals and married couples, respectively.
• Expands the Child Tax Credit from $1,000 to $2,000.
• Preserves the Child and Dependent Care Tax Credit.
• Preserves the Adoption Tax Credit.
• Expands the Medical Expense Deduction for 2017 and 2018 for medical expenses exceeding 7.5% of adjusted gross income, and rising to 10% beginning in 2019.
• Maintains the Earned Income Tax Credit for low-income Americans.
• Estate Tax. The final bill doubles the estate tax exemption from the $5 million base set in 2011, to a new $11.2 million for individuals and $22.4 million for married couples. This will essentially make estate tax a non-issue for nearly every American Family. (Estate tax is estimated to only be paid by the richest 0.1% of American Families with the new tax plan)
• Like-Kind Exchanges. The final bill preserves the like-kind exchange benefit for real property.
• Individual Mandate. The final bill effectively repeals the Affordable Care Act’s (ACA) individual mandate by reducing the tax to zero.
• Repatriation Rate. The final bill includes slightly higher deemed repatriation rates at 15.5% for cash assets and 8% on illiquid assets.
• Banks clear beneficiaries as they see far more dessert than vegetables in final package. As expected, banks fared well in the final tax package. Banks should benefit from top-line growth if the package spurs economic activity, bottom-line growth as banks are generally full taxpayers, and possibly even a steepening yield curve as the package’s inflationary impact materializes. Furthermore, the final bill dropped the controversial FIFO proposal, repealed the corporate alternative minimum tax, and avoided the big bank tax conversation altogether.

The Mortgage Industry made the best of a bad hand. On balance, the final tax bill negatively impacts higher-end housing markets, but the mortgage industry softened the blow by securing a handful of victories in the eleventh hour.

We briefly discuss these issues below:

• Mortgage Interest Deduction: The final package maintains the mortgage interest deduction (MID) for existing mortgages, but limits the deduction to $750k of acquisition debt on mortgages originated after December 15, 2017. The $750k threshold splits the difference between the House and Senate plans. Debt on both first and second mortgages under the $750k threshold will be deductible, but the legislation suspends the deductibility of home equity lines of credit (HELOC). The MID treatment under current law, including the $1M threshold, would return in 2026 under the conference agreement. Zillow estimates that 44% of U.S. homes are worth enough to take advantage of the mortgage interest deduction under current law, but that figure will drop to 14% under the conference committee compromise.
• The bill allows up to $10,000 in state and local tax (SALT) deductions, which is slightly broader than original proposals focused exclusively on property tax. This will really hurt high value homeowners in high state income state taxes like California. Notably, the decimation of the SALT deduction, coupled with the doubled standard deduction, will inherently reduce the tax benefit of homeownership.
• Capital Gains Exclusion. In one of the clearest victories for the mortgage industry, the final package maintains the existing structure of the capital gains exclusion stemming from the sale of a home. Specifically, under previous law homeowners were allowed to exclude up to $250,000 from the sale of a home for individual filers and $500,000 for married couples filing jointly if they have lived in the home for two of the last five years. Previous House and Senate proposals would have materially altered this provision, which could have negatively impacted already constrained supply in certain markets, but the industry was able to secure an eleventh-hour victory by maintaining this law.

Taking a Goals-Based Approach to Investment Risk

Anthony Christensen

The real measure of risk is whether or not you reach your financial goals. After all, ask yourself this question: If you beat a benchmark in any given year but are not in a position to reach your financial goals, what have you accomplished?

While investors may view risk in a number of ways, the approach you take should always point you toward your long-term goals. Achieving your financial goals—especially your long-term goals—requires a highly disciplined approach that helps navigate the ups and downs of the market.

Many retail investors measure risk by trying to compare performance to a market index (or benchmark), such as the S&P 500, Dow Jones Industrial Average, Russell 2000, or the NASDAQ just to name a few. So, if it was a tough period and the benchmark was down 20% but your investment portfolio was down 18%, you “outperformed.” Relatively speaking, that’s not bad. And if you judge your success on beating the benchmark—congratulations you “succeeded”! Yet the fact is you’ve experienced a considerable loss in capital, which may put one or more of your financial goals at risk. There’s certainly not much comfort in that type of standard.

Goal-Based Investing Keeps Your Future in Sight

Another approach—likely to provide you with a more helpful long-term perspective—is to look at risk in a personal way. That is, risk can be based on your own unique life goals and the probability of meeting or falling short of those goals. This is known as a goal-based approach and it’s how we do things here at ACCESS Wealth Management. Goal-based investing has long been employed by large institutional investors in the management of their portfolios.

As your advisors, we like to help you integrate this approach. First, we review your financial profile and your short- and long-term objectives. From there, we build a portfolio that puts you on track to accomplish those objectives. Gauging portfolio risk and performance, then, is a matter of tracking the total returns of your portfolio and determining whether or not your goals are within reach. After all, investing should be about achieving the future you want for yourself and those important to you. We will work at all times to keep you on a path for you and your family to enjoy a Life Well Lived. Being in a position to realize your goals is the only true measure of successful investing.

After the Brexit Vote: What Lies Ahead for the Markets?

Anthony Christensen

Key Points:

• Voters have decided that the U.K. should exit the European Union.
• It may take some time for the shock to work through the economic, financial and political systems in the U.K. and Europe.
• It is expected to take at least 2 years for the U.K. to formally leave the 28 nation European Union.

As we are all aware by now, Britain voted to leave the European Union (EU) yesterday, June 23, 2016. We would term this development, commonly called a “Brexit,” a market and economic shock. International developed and emerging market stocks were up in June and over the 90 days leading up to this referendum, suggesting markets were not pricing in a Brexit outcome. The initial shock of the unexpected result prompted a sharp decline in stock markets around the world, and we believe it may take some time for the shock to fully work through the economic, financial and political systems in the U.K. and Europe. With no visible catalyst to halt the slide, the decline in global stocks may continue as the risk of a recession increases.

Today is a good reminder of why we do things the way we do. We use experienced active managers (who can and will make adjustments according to occurrences like these), balanced managers who split their allocations between stocks/bonds/cash, long/short managers who have the ability to make money in a rising or falling price environment, utilize forms of guaranteed retirement income, and invest in historically non-correlated assets like real estate—just to name a few.

As a result of Brexit and the uncertainty it brings, global stocks may fall further. No two market shocks are the same, but in some of the other shocks since the financial crisis, markets have recovered in three to four months. Since the end of the financial-crisis induced global recession in 2009, a series of shocks have helped to keep growth, inflation and stock market performance subdued. The shocks that have taken place in Japan, the United States and Europe may offer us some insight into the potential duration of the market impact of Brexit. To recap, we have highlighted below the major economic impactors since the recession of 2009:

• After the shock of a devastating earthquake and related nuclear accident in Japan on March 11, 2011, the Nikkei fell 16% during the next two trading days, but fully recovered those losses by July 8, 2011, a period of four months. It is worth noting that the lingering recession caused this initial rebound to fade into two back-to-back double-digit declines and rebounds until stocks finally recovered their losses by the end of 2012.
• After the congressional standoff over the U.S. debt ceiling saw the S&P 500® index slide 3% on August 1, 2011, members of the House cut a deal to end it on August 2, prompting U.S. stocks to have a one-day rebound on August 3. But they fell another 12% over the next two months on fears of economic fallout, finally bottoming on October 3, 2011. The S&P 500 recouped these losses by the end of October, a period of three months.
• The European debt crisis forced Spain to unveil an austere budget and prompted labor strikes in “too big to bail” Spain on March 27-29, 2012, and effected a shock that drove the STOXX 600 down 3%. It went on to fall a total of 11% by June 4, as the Eurozone slid into a recession. By the end of July, stocks had recovered their losses, a period of three months.

Although the Brexit is not a perfect parallel with any of the above shocks, the delayed recognition of widening impacts from shock events could prompt a further slide in the stock markets after the initial reaction, as we have seen in the past. It is important for long-term investors to note that in each of these instances stocks rebounded to their pre-shock level in three or four months, even when a recession took place. We believe maintaining our long-term strategies in diversified asset allocations will continue to help us weather volatility on the path to our long term goals.

As we look ahead, some of the widening impacts of Brexit may include:

• Other countries calling for their own referendums on EU membership. This could put the European Central Bank in a difficult position to continue their quantitative-easing program of buying the bonds of countries that may choose to leave the Eurozone. It’s not hard to see France’s Marine Le Pen taking the same path as Britain, should she win the election in less than a year from now. A “Frexit” could be even bigger than Brexit in its impact on markets, with a European Central Bank that may be unable to effectively intervene.
• A battle may begin among those who want to replace U.K. Prime Minister David Cameron, who has announced he will step down in a few months, with each candidate arguing he or she will be most aggressive in negotiations with the EU. In response, the EU leaders in Brussels will make it clear they intend to be tough on the U.K. to make them an example. As the rhetoric heats up, the markets may become increasingly pessimistic regarding a trade deal that could be mutually damaging. Negotiations could drag out for years.
• A rise in the U.S. dollar, as investors seek safe havens, would likely contribute to declines in commodity prices. This may renew cuts to earnings estimates and prompt an eventual devaluation of the Chinese yuan versus the U.S. dollar. These factors, combined with slower export growth to Europe (China’s biggest customer), may renew concerns about an economic hard landing for China. In addition, a rise in the dollar could add pressure on emerging market stocks due to concerns about dollar-denominated debts and tighter financial conditions.
• A return to recession in Europe as fear of a breakup begins to slowly impact capital investment, hiring, and consumption.

With all of this said, we do not believe “Brexit” to be the real issue. By itself, Brexit is likely not a major issue for the global economy. The real issues are political volatility, global economic fragility, and the prospect of the world economy tilting into recession. If the economy does not fall into a recession, markets are likely to bounce back in the short term.

We will have additional comments as warranted and will also send you comments directly from the experienced managers that you are personally invested with. For now, we see this as one event in a series of constant and ongoing global economic events and no reason for panic. Nonetheless and as always, we will be watching developments and will remain vigilant.

How Low Could They Go? Negative Interest Rates Explained

Anthony Christensen

One of the first times negative interest rates appeared on the radar for many investors was in 2012, when the Danish National Bank pushed its deposit rate below zero. It seemed like an outlier event at the time, but since then more central banks in Europe and Japan’s central bank have also adopted sub-zero-interest-rate policies. This is commonly referred to as Negative Interest Rate Policy, or NIRP.

To understand the current global wave of negative interest rates—and whether it’s likely that the U.S. would embrace them—it helps to examine both their theoretical appeal and how they’re actually playing out in the real world.

The intended upside of negative rates

There is collectively almost $8 trillion worth of government bonds in parts of Europe and in Japan that are offering negative interest rates to investors. Buyers of these bonds essentially have to pay these governments money to buy their bonds. Said another way, investors who buy bonds with negative yields are paying the borrower. And while negative rates may not make sense at first blush, some central banks are experimenting with this strategy in an attempt to either boost inflation (European Central Bank and Bank of Japan) or to prevent their currencies from going up in value (Denmark and Switzerland).

By charging interest to commercial banks when they park their excess reserves overnight with the central bank, the European Central Bank and the Bank of Japan are attempting to encourage commercial banks to help jumpstart stalled economies, by forcing them to lend their reserves to businesses and consumers. The logic is that no commercial bank wants to lose money by parking reserves when they can make money by lending.

The incentive to lend should, in theory, drive more borrowing, which would lead to spending and investment. Consumers could see lower mortgage and loan rates, spurring home and auto sales. For businesses, lower rates could encourage investments in technology, infrastructure and staff, potentially leading to higher employment.

And what if negative rates were passed on to ordinary savers in the form of negative interest rates on savings accounts? In theory, that could also boost the economy. After all, you wouldn’t want to put your money into a savings account if it was going to lose money, would you?

With these potential benefits, going negative may sound like a legitimate way for a country to rev up its economy and reduce unemployment. But thus far, real-world results haven’t exactly turned out as planned. In fact, negative rates have led to a series of unintended consequences.

When negative rates don’t deliver positive results

In many countries where negative interest rates have been implemented, the results have actually indicated that there has been a diminished amount of credit available to individuals and businesses. The negative rates at the short end of the yield curve have sharply reduced the spread between short- and long-term interest rates, making lending less profitable for banks. As such, banks have responded by lending less.

Meanwhile, the negative interest rate environment has yet to spur much consumer spending. “The banks haven’t passed on negative rates to their depositors because they’re afraid that people will pull their money out,” says Kathy Jones, senior vice president and chief fixed income strategist at the Schwab Center for Financial Research. Instead, commercial banks in negative-rate countries have opted to increase certain fees they charge customers, in an attempt to recover some of their losses.

Could negative rates happen in the U.S.?

When Federal Reserve Chair Janet Yellen asked US banks to include a negative interest-rate scenario in their annual stress tests earlier this year, investors took notice. However, we believe these concerns are premature. A move to negative interest rates would require overcoming logistical—and possibly legal—hurdles. The Fed might even need the blessing of Congress. Given how controversial negative interest rates are, the Fed wouldn’t likely get this through Congress during an election year.

Also, Fed policymakers are well aware of the dubious record of negative interest rates when it comes to stimulating economic growth. “The lack of a boost provided by negative rates in Japan and the E.U. is another reason the Fed wouldn’t want to go down that path,” Jones says.

Moreover, the U.S. economy is outperforming most other major economies—and does not appear to be struggling with deflation. In fact, the Fed appears to be trying to raise interest rates, not lower them into negative territory, and the market seems to agree, for a change. Jones points to the Fed funds futures contract as a bellwether of U.S. monetary policy. The Fed funds contract is currently priced for more interest rate increases later this year.

“The trend toward negative rates is still a perplexing one that bears watching, especially if they move further into negative territory and achieve different results,” Jones says. “But for now, we don’t believe US investors should be alarmed. We believe that negative interest rates are unlikely to happen in the United States.”