Category Archive: Uncategorized

1. Why Investors Should Look Past 2017’s Massive Hurricane Damage

   September 25, 2017

   

   Hurricane Harvey seen through the cupola of the International Space Station.

   You’d be excused if you are concerned that the record-setting hurricanes – particularly Hurricanes Harvey and Irma – that hit the United States in August and September 2017 were going to wreak havoc with the economy and stock market for some time to come.

   After all, 2017 was the first time that two major Category 4 hurricanes made landfall here in the same season. Each was huge, with Harvey – described as a “1,000-year” storm — dumping more than 50 inches of rain around Houston, and Irma – at 400 miles wide – knocking out power for most of Florida and going on to inundate four more Southeastern states. Surely, they imposed massive costs:

   • Flooding caused 20 Houston-area refineries, some of the biggest in the nation, to be shut down entirely or in part. This sent the average price of gasoline up nearly 12 percent to $2.69 a gallon in the biggest hike since Hurricane Katrina hit the Gulf Coast in 2005.

   • The U.S. Department of Labor reported that jobless claims spiked in the wake of Harvey by some 62,000 to 298,000. The largest increase in initial claims since April 18, 2015, and a slight bump up in unemployment.

   • Total losses, including damages to home and businesses, are estimated by some at $290 billion. This is equal to 1.5% of U.S. GDP, a daunting figure considering the economy grew only by that much in 2016.

   But while that may sound like a prescription for economic and stock market catastrophe, history demonstrates that it pays for investors to remain calm, because the negative repercussions are typically short-lived and shallow. (That is, of course, unless you’re one of those who were directly in the hurricanes’ path.)

   The table below shows what happened to the U.S. economy, as measured by quarterly changes in gross domestic product, in the aftermath of 10 of the strongest and most costly hurricanes to hit the country since 1950. Only three – Donna in 1960, Camille and Ike — were associated with negative growth that very quarter (note that Ike occurred in the midst of the worst decline since the 1930s), and just three — Hazel, Carla and Andrew – were followed by slower, but still positive growth. More significantly, however, the effects were small.

   How to explain that? A few things: insurance (both private and federal), federal disaster relief and some job creation. So, while the storms have a short-term effect in shutting down businesses and reducing economic activity in some industries and places, the financial and fiscal response has a meaningful, countervailing stimulative effect.

   Date	Storm	Strength	Damages (In 2017 Dollars)	Same Qtr. GDP	Next Qtr. GDP	2d Qtr. Later GDP
   8/29/2005	Katrina	Cat 3	$136.2 Bln	+0.6%	+1.2%	+0.3%
   10/29/2012	Sandy	Tropical Storm	$75.4 Bln	+0.7%	+0.2%	+0.8%
   8/24/1992	Andrew	Cat 5	$45.8 Bln	+1.0%	+0.2%	+0.6%
   9/13/2008	Ike	Cat 2	$32.9 Bln	-2.1%	-1.4%	-0.1%
   8/13/2004	Charlie	Cat 4	$19.3 Bln	+0.9%	+1.1%	+0.5%
   9/22/1989	Hugo	Cat 4	$19.3 Bln	+0.2%	+1.1%	+0.4%
   8/18/1969	Camille	Cat 5	$9.4 Bln	-0.4%	-0.2%	+0.2%
   9/10/1960	Donna	Cat 4	$7.5 Bln	-1.2%	+0.7%	+1.9%
   9/12/1961	Carla	Cat 4	$2.7 Bln	+2.0%	+1.8%	+1.1%
   10/15/1954	Hazel	Cat 4	$2.6 Bln	+2.9%	+1.6%	+1.3%

   Sources: U.S. Federal Reserve, National Oceanic and Atmospheric Administration, J.P. Morgan

   With estimated damages totaling more than twice Katrina’s, it remains to be seen what effect Harvey and Irma will have on the economy, but it seems reasonable to expect roughly similar consequences – short and shallow. At least, that’s the consensus view among economists and investment strategists, like Gus Faucher, chief economist at PNC Financial Services Group, and Jim Baird, partner and chief investment officer at Plante Moran Financial Advisers.

   “U.S. economic growth may briefly slow in the third quarter,” said Faucher in a note to clients, “but [it] should bounce back later this year and into 2018.”

   Plante said: “The near-term economic impact of what increasingly appears to be two severe natural disasters in close proximity to one another will be a clear negative, and disruptive to the regional economies in the impacted areas. Having said that, the national economy appears to remain on track.”

   And what about the stock market? Again, the broad market appears to have shrugged off Harvey and Irma. The Dow gave up 234 points on September 5, but that was just 1.1% of its value, and gained all of back and more by September 11. The Standard & Poor’s 500 followed a similar, slightly less volatile pattern.

   That’s not to say there haven’t been losers. As is often the case with big natural disasters, hardest hit were property and casualty insurers. The S&P index for that industry fell more than 54 points, or 10 percent from its 2017 high of 538.62, which it reached on August 9, to 483.80 by September 7, and was still off nearly 5 percent by the September 13 close.

   Meanwhile, cruise line giants Royal Caribbean (NYSE: RCL) and Carnival (NYSE: CCL) – some of whose Caribbean destinations have been devastated — suffered just half of property and casualty insurers’ price losses, and as of this writing have made virtually all of the losses back.

   On the plus side, select building supply stocks have put in sharp gains since mid-August, with USG Group (NYSE: USG) up more than 20 percent and Eagle Materials (NYSE: EXP) up nearly 14 percent. Home improvement retailers like Home Depot (NYSE: HD) and Lowe’s (NYSE: LOW) have also done well, both having risen some 10 percent after August 31, and appear to be holding those gains, at least for now.

   Our general position is to avoid overreacting to any financial headline news from the recent storms. In our view, not only should portfolios be based on fundamentals but there is little data that suggests hurricanes have a negative economic impact. Better to look past the storms and steer a steady course.

   
   

2. Why the Fed Is Raising Interest Rates and What It Means

   August 10, 2017

   

   Unless you’ve spent the last eight years on Mars or asleep, you know that the biggest complaint is that the U.S. economy is sluggish:

   • At an average growth rate of around 2% a year, the country’s recovery following the Great Recession of 2007-2009 has been the weakest since World War II.
   • The economy hasn’t grown at an annual rate of 3% in the last 12 years.
   • The latest GDP report showed that in the first quarter of this year, the economy grew at an annualized rate of just 1.4%, and the New York Federal Reserve Bank estimates second-quarter growth at 1.9%.

   So why, then, you might ask, did the Federal Reserve Board – the country’s central bank – raise interest rates by 0.25% to 1.25% on June 14? It was the second such hike this year, and the third since the Fall of 2015. Before we answer the question, let’s take a few steps back to understand why and how the Fed changes interest rates.

   By law, the Federal Reserve Board has two objectives: to maintain a stable currency by keeping inflation low, and to seek full employment. Its primary tool for accomplishing that is the target interest rate it sets for overnight loans between banks that are members of the Federal Reserve system.

   The Fed defines an amount of reserve deposits every bank has to meet at the end of every day, and when a bank runs short, it’s forced to borrow money from banks that have excess reserves on hand. The rate for these loans is called the “Federal Funds Rate,” and the lending banks have incentives to charge the Fed’s target rate on these overnight loans. While the rate actually fluctuates daily around the Fed’s target, it represents a basic cost for banks. Its effect ripples through the entire financial system in terms of the rates banks charge borrowers, both businesses and consumers alike.

   By making loans more expensive, the Fed slows spending, as borrowers have less cash to pay for goods and services. The resulting reduction in demand puts the brakes on the economy and inflation. The opposite is also true. When the Fed lowers rates, borrowers have more cash to spend, and if they do in fact spend it, the economy grows more quickly.

   One of the by-products of rapid economic growth is inflation. When inflation gets out of control – as it did in the 1970s – the Fed raises interest rates to suppress demand. If rates get too high, they not only can cause inflation and growth to slow down but bring on a recession. The graph below shows the history of the Fed’s effective changes to the Fed Funds Rate interest rate; the grey bands highlight recessions, periods when the economy contracted. Generally, as you can see, the Fed raised the Fed Funds Rate leading up to a recession.

   

   There have been few times when the U.S. inflation rate has hit double digits. Two of those times were in 1973-75, when it reached 11.8%, and in 1981 and 1982, then it was at 13.9% and 11.8%, respectively. As you can see in the graph, the Fed responded by raising the Federal Funds rate.

   In the early 1970s, the U.S. economy was hot: it grew by more than 5% a year in 1971 and 1972, unemployment fell from 6.0% in 1971 to 4.9% by 1974, and inflation zoomed from 3.3% to 12.3% over the same period. The Fed responded raising its target Federal Funds rate six times, from a low of 3.5% in January 1971 to a high of 13.0% by July 1974, by as much as 4 percentage points at a time. The Fed’s actions precipitated a 16-month recession that resulted in a 3.2% loss in Gross Domestic Product (GDP) and unemployment reaching a high of 9%. Inflation bottomed out at 4.9% in 1976.

   Recovery from the 1973-75 recession was fast and furious. In 1978, the economy grew 5.6%, but in that same year prices rose 13.3%. Again, the Fed intervened, raising its Fed Funds target rate as high as 20.0% four times, in March and December 1980, and in January and May of 1981. This time there was a “double dip recession.” The first dip lasting just six months in 1980, and the second running from July 1981 to November 1982. In the first recession, unemployment peaked at 7.8% and the economy contracted by 2.2%. In the second, unemployment reached a high of 10.8%, and the economy gave up 2.7% of activity. There was pain and suffering throughout, but by 1984 inflation had been “tamed” at just 3.9%.

   Today’s U.S. economy looks almost nothing like the two episodes we’ve just studied. We’re eight years out of the Great Recession, and the economy is huffing and puffing along. As of June, GDP was growing at an estimated annual rate of around 2% and inflation was about the same. To rescue and revive the economy, the Fed lowered its Fed Funds target to an all-time low of 0.25% in December 2008. That rate prevailed until late 2015 when, as we’ve noted, the Fed raised it by 0.25% to 0.50%, followed by two more equal hikes this year. But with growth and inflation feeble, we return to our opening question: why?

   The answer lies in the Fed’s second objective: to maintain full employment, which economists define as between 4.0% and 5.0%. That’s the level at which business competition for labor intensifies and wages typically begin to rise, threatening higher inflation. The rate as of June was 4.4%, right in the Fed’s sweet spot. So was inflation: the Fed’s target rate for that is 2%, and that is where the inflation rate now stands. While there hasn’t been any marked increase in inflation yet, it’s generally acknowledged that it takes 18 months for Fed actions to have their intended effect, so the Fed has been acting against inflationary pressures that it believes will appear late next year.

   So, both of the Fed’s goals for the economy have already been achieved. In the view of the Fed’s governors, therefore, it’s time to remove the monetary stimulus of low interest rates. In fact, Fed watchers believe the central bank will continue to raise its Fed target rate by the same, modest 0.25% bump, as many as two more times by the end of 2018.

   Underlying that view is that the economy is continuing to expand, supported by the fact that the stock market has continued to advance to all-time highs. What’s more, a study published in 2015 by Stanford University economist Charles I. Jones found that the U.S. economy’s long-term growth rate, going back as far as 1870, is 2.0% – approximately where it is expected to be for this year -– and that the higher rates of growth it achieved after World War II were an aberration, not the norm.

   As Forbes magazine contributor Len Sherman asked in a headline on June 2, “Can the U.S. Ever Get Back to 3% Growth?” Perhaps. That is, after all, one full point below President Trump’s stated goal. But if we get there, you can expect the Fed to have raised the Fed Funds Rate several, if not many times more.

   
   

3. Trump Wants to Cut Taxes by $6+ Trillion: Who Gets What?

   March 30, 2017

   

   President Donald Trump has proposed the largest tax cut since Ronald Reagan’s 1981 plan, totaling some $6 .2 trillion (yes, that’s right – “trillion” with a “t”) over ten years, with most of it going to the wealthy and to businesses. If that means you, you have reason to smile – at least for now.

   At the moment, Trump’s plan is only a proposal, and it has already been revised twice since he unveiled it as a candidate for the presidency in 2015. That revision lopped off about $3 trillion in cuts, and the current proposal has yet to be written up in a bill to present to Congress. Still, it’s twice as large as House Republicans are calling for.

   Given that Trump wants to increase spending on both the military and infrastructure while holding Medicare and Social Security benefits steady, economists say that without huge cuts in other kinds of spending his tax plan would dramatically increase both the federal budget deficit and government debt, effects that are anathema to every Republican in Congress.

   In this light, it’s premature to expect every feature of the Trump tax plan to be signed into law. But, after the repeal and replacement of the Affordable Care Act, a huge tax cut combined with tax simplification, is the primary domestic legislative objective of both the Trump administration and congressional Republicans. It’s reasonable to expect that when passed, the new tax code will resemble many of the features, if not their precise values, that Trump has put forward.

   So, without further ado, here’s a summary of the Trump tax plan and how it would affect taxpayers. First, we’ll look at changes in personal taxes, and then the changes proposed for business taxes.

   Personal Taxes

   There are eight key changes to personal taxes in the Trump proposal:

   • Lowering tax rates and collapsing the current seven brackets into three, as shown here:

   2016 Brackets

   Marginal Tax Rate	Single Filer Income	Joint Filer Income
   10%	$0 – $9,275	$0 – $18,550
   15%	$9,276 – $37,650	$18,551 – $75,300
   25%	$37,651 – $91,150	$75,301 – $151,900
   28%	$91,151 – $190,150	$151,901 – $231,450
   33%	$181,151 – $413,350	$231,451 – $413,350
   35%	$413,351 – $425,050	$413,351 – $466,900
   39.6%	$425,051+	$466,901+

   
   Trump Brackets (latest)
    

   Marginal Tax Rate	Single Filer Income	Joint Filer Income
   12%	$0 – $37,499	$0 – $74,999
   25%	$37,500 – $112,499	$75,000 – $224,999
   33%	$112,500+	$225,000+

   • Raising the standard deduction from $6,000 per person to $15,000 for single filers and $30,000 for joint filers, while repealing personal exemptions.

   • Allowing deductions for care for children under the age of 13, and the creation of tax-advantaged Dependent Care Savings Accounts.

   • Eliminating the Head of Household filing status (for unmarried filers with children under the age of 19 and/or disabled dependents).

   • Capping itemized deductions to $100,000 for single filers and $200,000 for joint filers.

   • Elimination of the Affordable Care Act’s 3.8% investment income tax (assessed in 2016 against those in the two highest income tax brackets).

   • Eliminating estate and gift taxes, while assessing capital gains taxes on the owner’s death, subject to a $5 million exemption for individuals and $10 million for married couples.

   • Eliminating the Alternative Minimum Tax.

   What’s the potential impact of these changes? According to an analysis by the Tax Policy Institute, “the plan would cut taxes at every income level, but high-income taxpayers would receive the biggest cuts, both in dollar terms and as a percentage of income.” The Institute went on to note that the plan would:

   • Cut the average household 2017 tax bill by $2,940 and increase after-tax income by 4.1%, but

   • Reduce the bill for the highest-income taxpayers (those with incomes of more than $3.7 million) by almost $1.1. million, or more than 14% of after-tax income.

   • For households in the middle fifth of income, cut taxes by an average of $1.010, or 1.8% of after-tax income.

   • Provide an average reduction of $110 or 0.8% of after-tax income for the poorest fifth of all households.

   • Marginally increase the tax bill for people who previously filed as a head of household and for large families.

   The tables below shows the proposed migration of household income from the 2016 tax brackets to the brackets in Trump’s latest proposal:

   
   Single Filers Adjusted Gross Income
    

   Over	Up To	Current Marginal Rate	Trump Marginal Rate
   $0	$10,350	0%	0%
   $10,350	$15,000	10%	0%
   $15,000	$19,625	10%	12%
   $19,625	$48,000	15%	12%
   $48,000	$52,500	25%	12%
   $52,500	$101,500	25%	25%
   $101,500	$127,500	28%	25%
   $127,500	$200,500	28%	33%
   $200,500	$423,700	33%	33%
   $423,700	$425,400	35%	33%
   $425,400	Unlimited	39.6%	33%

   
   Joint Filers – No Dependents Adjusted Gross Income
    

   Over	Up To	Current Marginal Rate	Trump Marginal Rate
   $0	$20,700	0%	0%
   $20,700	$30,000	10%	0%
   $30,000	$39,250	15%	12%
   $39,250	$96,000	25%	12%
   $96,000	$105,000	25%	25%
   $105,000	$172,600	28%	25%
   $172,600	$252,150	33%	25%
   $252,150	$255,000	33%	25%
   $255,000	$433,750	33%	33%
   $433,750	$487,650	35%	33%
   $487,650	Unlimited	39.6%	33%

   Source: Tax Policy Institute, Oct. 11, 2016

   
   The following table shows how tax bills would change under the current Trump proposal by household income percentile:
    

   Quintile/Percentage	Change in After-Tax Income	Share of Federal Tax Change	Average Federal Tax Rate Change	Average Federal Tax Rate Percent Change	Average Federal Tax Rate Under Proposal
   Lowest Percentile	+.08%	1.1%	-$110	-0.8%	2.9%
   Second Quintile	+1.2%	3.0%	-$400	-1.1%	7.3%
   Middle Quintile	+1.8%	6.6%	$-1,010	-1.5%	12.1%
   Fourth Quintile	+2.2%	11.3%	-$2,030	-1.8%	15.5%
   Top Quintile	+6.6%	77.7%	-$16,660	-4.9%	21.2%
   ALL	+4.1%	100%	-$2,940	-3.3%	16.8%
   UPPER PERCENTILES
   80-90%	+2.3%	7.9%	-$3,270	-1.9%	18.3%
   90-90%	+2.8%	6.2%	-$5,350	-2.1%	20.0%
   95-99%	+6.0%	16.3%	-$18,490	-4.5%	21.0%
   Top 1 Percent	+13.5%	47.3%	-$214,690	-9.0%	24.4%
   Top 0.1 Percent	+14.2%	24.2%	-$1,066,460	-9.3%	25.1%

   Source: Tax Policy Institute, Oct. 11, 2016

   Business Taxes

   The leading feature of the Trump tax plan for business is a reduction in the nominal top income tax rate by more than half. But the Trump administration has said that its proposed changes in business taxation would be “revenue neutral ,” in part because of the elimination of various “special interest” tax breaks and increased revenues from the repatriation of foreign profits. While that may be true, depending on the industry and size of company, some businesses would pay more in taxes while others would pay more.

   Here is a summary of Trump’s proposed changes for business:

   • Reducing the top corporate income tax rate from 35% – nominally, among the world’s highest when state and local taxes are taken into account – to 15%.

   • Owners of “pass-through” enterprises — sole proprietorships, partnerships and S corporations – would be subject to a 15% tax on pass-through income instead of their corresponding personal income tax rate.

   • The ability to deduct the full amount of capital investments (equipment, plant and inventories) in the year they are made instead of depreciating them over a number of years. If taken, however, businesses will not then be able to deduct interest expenses.

   • For multinational businesses, a one-time 10% tax on repatriated cash holdings, payable over 10 years – a measure Trump expects to result in $2 trillion flowing back to the United States; and no income tax on future foreign profits.

   • A border adjustment tax on imported goods and an exemption on exports. The President and his advisers anticipate that the tax would raise $1 trillion over 10 years. Critics of the measure argue that businesses would pass on the tax on imports to U.S. consumers by raising prices, while supporters argue that those higher prices would be offset by a stronger U.S. dollar.

   It’s unclear when the Trump administration will submit a bill to the House of Representatives, where tax legislation originates, when it is likely to become law and how much the law will resemble the President’s current proposal. The current House proposal undercuts Trump’s tax cuts by about half, so there is a wide gap to be resolved. It’s probable, however, that as long as Republicans control both the White House and Congress, federal taxes will be lowered and the tax code simplified.

   
   

4. What Your Credit Score Means and How You Can Improve It

   November 16, 2016

   

   Your credit score is one of the most important parts of your financial identity. A bad score can prevent you from buying the home of your dreams, saddle you with tens of thousands of dollars in additional interest expense over your lifetime, keep you from being hired for the job you want, or prevent you from being approved for a life insurance policy. On the other hand, a good score can open many doors and with smart debt management, help you live a happier life.

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5. Tax-Advantaged Investing for College

   August 24, 2016

   

   With the price of a college education continuing to increase faster than the rate of inflation, it’s necessary to do more than just save for it. Unless your child is going to qualify for a full scholarship, you’re best advised to invest for it. This means placing the money you put aside for college so that it gets all the help it can to grow faster than college costs rise.

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6. After the Brexit Vote: “Keep Calm and Carry On”

   July 20, 2016

   

   It was the summer of 1939 – believing that war and the bombing of British cities were unavoidable – the British government was concerned with maintaining civilian morale. So it spun out a typically British, stiff-upper-lip phrase designed to boost confidence and printed it on more than two million posters – which, oddly, it never actually distributed. Today, though, you can find the phrase and various permutations of it appearing on posters, tee shirts, tea mugs and all sorts of decorative wear: “Keep Calm and Carry On.” (more…)
   

7. Why the “Dividend Aristocrats” Belong in Your Portfolio

   June 14, 2016

   

   Even the most conservative investors ought to have some stocks in their portfolio, since they are one of the few asset classes whose long-term returns stay ahead of inflation. Still, the ups and downs of individual stocks and the stock market as a whole are often too much for the very risk-averse.

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8. Stock Markets and Presidential Elections: A Pattern You Shouldn’t Count On

   May 24, 2016

   

   “There are three kinds of lies: lies, damned lies and statistics.” – Origin uncertain

   Nobody really knows the origin of the quote above, often attributed to 19th century British Prime Minister Benjamin Disraeli, but we want to cite it here to caution investors against placing bets on historical trends in the stock market.

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