How fast things change in just one year! CNN has an emotion-based measurement, the Fear & Greed Index. One year ago, on a scale of 1-100, the index was at 12, indicating intense fear. You may recall that the year began on the heels of a sharp decline in December of 2018 as the S&P 500 finished in negative territory. One year later, at the end of December 2019 with the S&P 500 returning 30+%, the index now exhibits extreme greed at 94, indicating elevated risks.
In some ways, the market has corrected itself to a more appropriate level. Earnings per share grew in 2018 following the corporate tax cuts, yet multiples stagnated. In the 3rd quarter of 2019, earnings per share were down 3.8% from the previous year, but the forward price to earnings ratio rose to 18, which is 11.8% higher than its 25 year average. Given the Federal Reserve’s interest rate cuts in 2019, it is reasonable to believe that investors would pay a small premium for stocks given the alternative of low yields in the bond market.
As we look forward to 2020, expectations should certainly be tempered. One indicator we have written about in the past referred to the amount of cash that Americans had on hand. The thesis essentially was that there was still room for the market to run given the amount of cash on the sidelines that could still be deployed. However, according to the American Association of Individual Investors, its subscribers’ average cash balance today is near 14%. This nearly matches the lowest amount of cash in 20 years (it was 13% during the dot-com peak of 2000). For reference, cash reached 45% at the market low in 2009.
We are not predicting a recession in 2020. The unemployment rate continues to fall with strong job growth, although job openings are now slowing. Wage growth could tick up to 4.0% in to 2020, providing consumers with more money to pump back into the economy. As such, we will continue to look for value opportunities in high quality, high dividend paying stocks as well as internationally, where stock valuations are 70% of what they are in the United States.
Congress Passes the SECURE Act
As part of an end of the year spending bill, President Trump signed the SECURE Act into law which provides some give and take for investors to consider. First, the good news:
• Required Minimum Distributions (RMD’s), which are forced withdrawals from retirement accounts in order to generate tax revenue, can now be delayed until age 72 for those who hadn’t already started them (previously, it was the year in which you turned 70 ½). Those clients born after July 1st 1949 all fall into that category.
• There is now no maximum age for contributing to an IRA (previously, this was also the year you turned 70 ½), but you or your spouse still has to have earned income in order to contribute.
• There are new tax credits available to small businesses owners who start a 401(k) and/or elect auto-enrollment into their plans.
Now for the bad news: Previously, you would be able to leave an IRA to a child (or any non-spouse beneficiary) and that person would be able to take small Required Minimum Distributions over their lifespan. These so-called “stretch IRA’s” ensured that the tax impact of those withdrawals could be minimized. Now, non-spouse beneficiaries will be required to make a full withdrawal within 10 years. That could push the beneficiary into a higher tax bracket in the year(s) they take withdrawals. There is no change for spouses inheriting IRA’s and there is also a carve-out for minor children and beneficiaries with special needs to still be able to stretch the inherited IRA’s over their lifetimes.
This change will now make Roth conversions more prevalent. In a Roth conversion, you convert a portion of your IRA to a Roth IRA, paying the taxes on the amount converted. However, clients will want to carefully consider the income tax impact of this conversion. It may make more sense to elect to pay taxes at these current low rates, rather than have non-spousal beneficiaries be forced to take taxable distributions at higher future rates. The funds converted to a Roth IRA would then grow tax-free for life until eventually non-spousal beneficiaries inherit tax-free funds.
Beneficiary designations, Roth conversions and estate planning have always been an important part of our comprehensive planning for clients, but will be a particular point of emphasis this year during annual client reviews.
ETF Investment Models Become More Attractive in 2020
For several years, First National Corporation as employed the use of non-transaction fee ETFs for some accounts. This has allowed us to hold a diversified stock and bond mix with the ability to rebalance quarterly without the drag of transaction fees. Recently, Fidelity and Schwab announced that they would eliminate trading fees for all ETFs, allowing us an expanded universe of available ETFs for these portfolios. Many clients will see changes being made in their portfolio holdings over the next few weeks as we take advantage of the opportunity created by the elimination of transaction fees in our regular quarterly rebalancing.
Similarly, for the last 7 years, we have been implementing dynamic portfolio strategies called Chapoquoit for those clients with large enough portfolios to be able to absorb the previous transaction fees. These are tactical strategies that change allocations on a monthly basis based on macroeconomic factors such as changes in GDP, interest rates, productivity, etc. With trading fees eliminated, these strategies may now be appropriate for a much larger portion of our clients. All three of the strategies (Aggressive, Moderate and Conservative) are designed to minimize downside risk over a full market cycle (6-8 years). More information is available on our website. https://www.fncadvisor.com/chapoquoit-dynamic-portfolio-strategies If you would like to discuss whether these might be appropriate strategies for you, please do not hesitate to reach out to us.
New Tool to Analyze Your Tax Return
We recently adopted new tax-planning software which “reads” tax returns to assist us in making financial planning recommendations. An 80 page tax return can be concisely summarized within seconds, allowing for better wealth management strategies for you. There are no additional fees for this service and we only require a PDF file of your tax return (or a paper copy which we can scan to a PDF). If you are interested in having us look at your tax return to look for potential financial planning opportunities, please let us know.
As we begin a new year, we want to thank you for your trust and wish you good health and prosperity in 2020.