The Markets in 2018—Meet the new boss, same as the old boss
Any thoughts that 2018 might start with a pause in the bull market were quickly dispelled in the first week of the year. A “buy the rumor, sell the news” view on tax reform has shaken out to be more aptly described as buy the rumor and buy the news.
In my opinion, the credit goes to the dramatic reduction in the corporate tax rate—from 35% to 21%, beginning in 2018.
On January 1, analysts were forecasting a 12.2% rise in Q1 2018 S&P 500 profits (Thomson Reuters) —pretty impressive. By January 31, analysts had sharply raised the Q1 estimate by a full 5 percentage points to 17.2%.
There’s only one word to describe the dizzying upward surge in estimates—astounding. And it’s not simply Q1 2018; analysts have sharply boosted profit outlooks for all four quarters.
As I’ve mentioned in the past, earnings and expectations of earnings play a big role in the stock market price equation. The run-up we’ve witnessed, in my view, is due to investors pricing in a much rosier profit outlook.
Warren Buffett, who called the cut in the corporate tax rate a “big deal…a huge, huge reduction,” summed it up this way in a CNBC interview in the middle of last month—
“You had this major change in the silent stockholder in American business, who has been content with 35%…and now instead of getting a 35% interest in the earnings (he noted foreign earnings from U.S. firms are more complicated) they get 21% and that makes the remaining stock more valuable.”
It’s a unique and colorful way to describe the new tax regime.
By the end of January, a bout of volatility re-entered the landscape, as investors took note of an upward creep in Treasury bond yields. In February, the volatility dramatically rose and worldwide indices closed with losses between 4% and 6%.
Although this volatility may be unsettling, I see this is a healthy short-term pullback and a reaction to a rise in interest rates—all largely attributable to a rising economy. In fact, this is the first time the world's largest economies have grown in unison since 2008.
As of last week, the 10-year Treasury note yielded 2.85%, its highest yield since January 2014. (The 10-year Treasury note yielded an all-time low of 1.37% in July 2016).
What led to this rise in interest rates?
The interplay of the tax cut euphoria, banner corporate profits, increased supply of Treasury securities and the recent employment reports have triggered speculation that the Federal Reserve (to combat rising inflation) may likely increase rates more aggressively in 2018 than originally anticipated.
In regard to wage growth, hourly earnings were up 2.9 percent in January and upwardly revised for December to 0.4 percent; which suggests that we are on track for wage growth of 4 percent or more for 2018. This wage growth does not take into account the changes to the minimum wage and the effect of wage increases and bonuses as a result of the new tax plan. Consumption, as a consequence of the wage growth, should increase and reinforce more labor demand and lower unemployment.
The volatility and pullbacks over the past week are likely not over, but we appear to be nearing a bottom. This correction should be a healthy development for the markets in the long run, and the equity bull market, while bruised, is still in-tact.
The current environment is still supportive of equities. Favorable economic fundamentals are still in place, current valuations appear reasonable, and it’s not too late in the business cycle. As long as growth continues to improve, the inflation that we see now shouldn't be an issue. In other words, higher company revenues should offset the bite of rising costs, such as workers' pay, if inflation picks up. The tax cuts should also help bolster growth. Investors that buy equities here will likely be pleased come year-end, but the improvement in bond yields may make the argument for equities a bit more interesting for some investors.
Let me end this market commentary with a recent comment by Burton Malkiel.
He’s not a household name like Buffett, but he is the author of A Random Walk Down Wall Street, a well-known and well-respected book published in 1973.
“I think one of the cardinal rules of investing is don’t try to time the market. And the reason is that you’ll never get it right. I’ve been around this business for 50 years and I’ve never known anyone who could time the market and I’ve never known anyone who knows anyone who could time the market. You can’t do it. It’s very dangerous.”
It’s a reminder that stocks don’t rise in a straight line.
Busting 5 Big Retirement Myths
Urban legends, urban myths, and the latest that’s on everyone’s lips–fake news. Whatever you call it, in our age of information, claims of spurious repute can go viral in minutes. Anyone with a PC can start a blog and offer up opinions on just about any subject, whether he or she is an authority or not. Sources? Who needs sources.
OK, there’s a bit of sarcasm in that last comment, but I think you know where I’m going.
When it comes to retirement, there are plenty of misleading thoughts, opinions and fake news floating around out there. This month, I’d like to clear up some misconceptions that surround the retirement years. With that in mind, let’s jump in.
1. I’ll never see a penny of the money I put into Social Security.
If I had a nickel every time I heard someone utter that phrase. Sadly, if a 40-something says he is confident he will receive monthly checks, he sets himself up for ridicule among his contemporaries.
I wouldn’t disagree with the hypothesis that young people getting started in the workforce will receive a low return on contributions into Social Security, but that’s a completely different argument.
Back to the matter at hand, Social Security is not on the verge of bankruptcy, and I fully believe even those who are many years from retirement will be collecting monthly benefits when it’s their turn. Let me explain.
According to the 2017 annual report from the Social Security and Medicare Board of Trustees, Social Security “has collected roughly $19.9 trillion and paid out $17.1 trillion,” in its storied 82-year history, “leaving asset reserves of more than $2.8 trillion at the end of 2016 in its two trust funds.”
As an ever-larger number of baby boomers continue to retire and collect benefits, the trustees expect the trust funds to be depleted by 2034.
Thereafter, expected-tax-income receipts are projected to be sufficient to pay about three-quarters of scheduled benefits. Put another way, recipients of Social Security would receive about a 25% cut in benefits, if no changes are made to the current structure.
Of course, these are simply projections and much will depend on economic growth, job creation, and wages. Yet, it’s a far cry from, “I won’t see a penny of Social Security.”
I suspect that politicians will eventually settle on some type of compromise that will extend the life of the current system.
That said, I recognize that timing and strategies that can be implemented for Social Security may be complex. If you have questions, please give me a call or shoot me an email. I would be happy to discuss your options with you.
2. The stock market is too risky.
There’s no question about it, the bear markets that followed the dot.com bubble and the 2008 financial crisis were unprecedented, in that we saw two steep declines in less than 10 years.
Made fearful by what they see as too much risk, millennials have shied away from stocks, according to a Bankrate survey. What seems like a complete disconnect: Millennials seem to be far more interested in Bitcoin! The word speculative doesn’t even begin to describe Bitcoin. But let me get back on topic.
There has always been a degree of risk in stocks, even with a fully diversified portfolio. Yet, a well-diversified portfolio is akin to a stake in the U.S. and global economy. Moreover, the U.S. and global economy has been expanding for many decades. It may not be larger next year, but history tells us it will be bigger in 10 or 20 years.
When it comes to investing in stocks, I typically experience some resistance from folks who haven’t seriously entertained the idea before. I listen to their concerns, and answer with an array of factual data that’s not designed to win an argument, but simply to educate. When you have all the facts, then you can make an educated decision about what's best for you.
3. Medicare will handle all my health care needs in retirement.
If only Medicare did cover everything. But then, the cost to finance it would be much higher.
Medicare doesn’t cover the full cost of skilled nursing or rehabilitative care, according to AARP. Yes, the first 20 days of a stay in a nursing home is covered, but you’ll pay over $160 per day for days 21 through 100. And Medicare doesn’t cover stays past 100 days.
You may be paying out of pocket for personal care assistance, too. The same holds true for miscellaneous hospital costs, routine eye exams, hearing, foot and dental care.
4. Why save today when you can start tomorrow—there’s plenty of time.
This section is designed for millennials and those who are just beginning their journey in the workforce. There’s no better day to begin saving than today! I can’t stress this enough.
Let me give you a simple but telling example.
- Susan invests $5,000 annually between the age of 25 and 35 and earns 7% annually. She puts away a total of $50,000.
- Bill invests $5,000 annually between the age of 35 and 65 and earns 7% annually. He saves a total of $150,000.
- When Susan reaches 65, she will have amassed $602,070, while Bill will have $540,741.
Source: JP Morgan Asset Management
Lesson learned–the sooner you begin, the better off you will be as you approach retirement.
Take full advantage of your company’s retirement program. If your company doesn’t have a savings plan, there are many simple ways that you can get started. Feel free to reach out to me and I can assist you.
5. Retirement is easy.
Many look forward to the day when they will no longer prepare for Monday mornings at the office. For those who face the work challenges that crop up daily, retirement may seem like a welcome oasis in the distance.
But that oasis sometimes turns out to be a mirage. Often, the transition from decades of working to retirement isn’t so simple.
For a better retirement, set goals, and not simply financial ones. Can you transition to part-time in your job? Consider part-time employment or consulting. It will ease the transition, keep you busy, and extend your savings.
Volunteer with your local church or local community organizations. Are you familiar with Meetup.com? Look for groups with similar interests. You’ll not only derive an enormous amount of satisfaction from helping others, but you’ll meet like-minded folks and make new friends.
Try something new. Learn how to play a musical instrument.
Please, keep up any exercise routines—and it's never too late to start a new one. Check with your doctor, who will be happy to prescribe a fitness plan that’s suited to you.
Have you ever considered taking a class? How about writing a book? Expanding your knowledge or sharing your ideas can be quite fulfilling. Though well into his 70s and still happily working, one individual I know is writing a book to his kids. Now there’s a legacy!
The most important thing you can do to make retirement enjoyable is to stay active and keep your mind and body sharp.
I hope you’ve found this letter to be informative and helpful. If you have any questions or would like to discuss any matters, please feel free to email Eric@ElmTreeCapital.com or give my office a call at (781) 236-0802.