In The News...

The number of U.S. jobs fell for the first time in 7 years. And it may not be a big deal.

First, the facts...

A total of -33,000 jobs were lost in September. This followed the prior three months where an average of +180,000 jobs per-month were added.
Despite this jobs decline, the unemployment rate fell from 4.4% to 4.2%.
The participation rate improved to 63.1%. This measures the number of those either working or looking for work as compared to the total working-age population.

How can this be? How could unemployment improve as jobs are being lost? Two reasons: Hurricanes Harvey and Irma. Those natural disasters threw off the census that measures the number of jobs added or lost for the month, called the Establishment Survey. In this poll, anyone unpaid for whatever week the 12th falls on is considered unemployed. While the Department of Labor claims the hurricanes skewed the -33,000 job-loss figure, the DOL does not believe it affected the unemployment figure of 4.2% or the participation rate, both of which are computed by the other employment census -- the Household Survey.

Household Survey: This census considers anyone with a job as employed for the month, even if they miss work the week the 12th falls on. I mention this because "Employment falls for the first time in 7 years!" will likely lead news headlines. Ironically, President Trump has long-called the Dept of Labor jobs numbers "false" or "phony", but this time the unemployment numbers may actually be misleading given the unique impact of two massive hurricanes striking within weeks of each other.

The eye of the beholder: It certainly does not help that we have dozens of different ways to interpret employment data. Depending on your bias you could find any nugget you want and use that data point to argue whether the jobs market is doing well or poorly. In my opinion, the participation rate matters as much as anything because it gives a complete view of employment relative to the total working-age population. Participation had been on the decline since early-2000, until making a positive turnaround roughly two years ago. This will be key as more Baby Boomers retire and younger Millennials and Generation Z'ers step into the workforce.

In The Market...

The S&P 500 gained +1.3% this past week. Let's look under the hood:

STOCKS: The S&P 500 index climbed for the 4th-straight week and 6th time in the past seven weeks. So much for the volatile summer, huh? Since the blip in early-August the S&P has rallied +5.5% over the past seven weeks. Again everyone, this is bullish behavior. Eight of 10 sectors were higher last week, led by those we want to see leading amid a bull market -- Materials and Consumer Discretionary.

We sold our Financials sector fund (XLF) this past week for a nice gain of roughly 5%. Not all accounts owned this -- larger accounts and smaller, more aggressive accounts did. I still like Financials long-term but based on my analysis looking out over the next few weeks it made sense to take the gain and evaluate other options. One sector I am eyeing is Industrials (XLI).

BONDS: A down week for bonds, but not as bad as I would have expected given the S&P was up more than 1%. Of course, stocks and bonds are not negatively correlated anyway, even if they show tendencies from time to time. I don't read too much into this past week. For now I still favor the odds that bonds will rally in the coming weeks.

In Our Opinion...

It happened again.

As I sat down for lunch with someone I know through volunteer work, the first question I got was... "So when do you think the big correction will happen?"

I have written at-length about how I believe pessimism has fueled the stock market higher, though there are no data points to confirm/disprove that. Major market declines -- I am talking more than the -5% or -10% drops we see every year -- do not typically come until investors have become euphoric, or at the very least, complacent.

Looking at the data, stocks are technically "overbought" right now if you look at the Relative Strength Index (RSI). This measurement actually plays a central role in our analysis because it helps substantiate whether I believe a certain trend will continue or a new one is forming. RSI gauges price momentum by comparing the size of gains versus losses over a period of time. This is typically 14 periods, which could be 14 days, 14 weeks, 14 months, etc.

A RSI reading above 70.0 is considered "overbought". The S&P 500 is currently at a daily RSI reading of 78.0, a weekly RSI of 76.0 and a monthly RSI of 83.0. Sooooo, using the S&P as our barometer, the stock market is technically overbought on all three primary timeframes we use in our analysis. This would indicate that the market is overheated and due for a loss.

But it just isn't that straightforward. A stock can stay overbought for a very long time before ever realizing the sell-off that is expected. RSI is almost counter-intuitive in that way. Momentum breeds momentum until it doesn't, if that makes sense. Even when RSI falls back below 70.0 it often leads to greater demand among investors who want to buy the price dip, which in turn sends RSI higher as momentum picks back up.

To illustrate this, look at how the S&P 500 behave back in 2013 and then again during this current bull market rally. Notice that in 2013 the S&P ripped off another +30% gain after RSI crossed above 70.0 and was technically "overbought":

The opposite holds true too. When RSI for a particular investment falls below 30.0 it is considered "oversold" and due to rally. Similarly speaking, when this happens you have to be careful because the investment in-question can fall further and further and RSI can remain below 30.0 much longer than anticipated. This often occurs when investors unwittingly see that a stock has precipitously fallen in value and they buy it thinking they are getting a discount. More often than not that investment falls even further, resulting in unexpected losses for the investor who thought they were going to make some quick money.

The bottom line is that there is usually a reason an investment's value is rising or falling. If it is rising you should embrace the trend. If it is falling you do not want to be on the wrong side of that, hoping for a rebound. This is where trend-analysis matters, but I won't revisit that concept here.

In Our Portfolios...

Q&A/Financial Planning...

Will your income be lower than normal this year?
Are you 10 years or more away from retirement?
Are you retired and have enough savings to avoid dipping into your 401k or IRA?

If "yes" to any of these, you might want to consider converting a portion of your 401k or IRA account into a Roth IRA.

Why do a Roth IRA conversion? To lower your tax bill. Right now the money sitting in your 401k or IRA are pre-tax (unless you opted for the Roth 401k option), meaning you have deferred paying income taxes on those contributions and the earnings that stem from them until you retire. Eventually you will have to pay taxes as you withdraw money down the road. But if you convert now you will pay taxes today in exchange for never paying them again, no matter how large your account grows.

That last part is key, because I think we would agree that your account will be larger in the future than it is today (if you are still working). That means a much greater tax burden down the road. If you think your household income will be abnormally low this year, it might make sense to do a Roth IRA conversion so the funds can be subject to a lower tax bracket than they would be if you converted them next year.

But Brian, why not just wait until I am retired and withdraw money then? At that point I won't be working and my tax rate should be much lower anyway.

Fair point, but there are a few holes in that argument. First, remember what I just said about your savings being much greater by that point than they are today. Even if you are in a lower tax bracket in retirement, the gross amount of taxes you pay will cumulatively be greater than taking your tax medicine now on a smaller nest egg.

Also, by converting to a Roth IRA you avoid the Required Minimum Distribution (RMD) rules that kick in at age 70. The RMD rules mandate that you take out a certain amount from your tax-deferred 401k or IRA accounts each year until you die. This is the IRS' way of ensuring you eventually pay your taxes, rather than continuing to stockpile savings and deferring taxes even longer.

Though the RMD rules seem like a first-world problem to have, they can be annoying by forcing you to pay taxes. They can also make other parts of your life expensive. For instance, your Medicare Part B premiums increase as your income exceeds certain thresholds. RMD withdrawals will send your income higher and higher, particularly when you add in other sources like Social Security or pensions.

If you are nearing retirement, consider mapping out whether it makes sense to convert some portion of your tax-deferred savings. You can convert as little or as much as you want. For example, you could take a $50,000 IRA and convert $10,000 of it every year for 5 years, thus spreading out the tax burden across five tax returns. This may pose an administrative headache over time, but it is still an option.

One last thing: I want to make sure I distinguish a Roth IRA conversion from a Roth contribution. A Roth conversion is taking pre-tax ("tax-deferred") IRA funds already in existence and turning them into Roth IRA funds. A Roth contribution is making a deposit of cash into your Roth IRA. The maximum you can contribute is $5,500 if under age 50 and $6,500 if older, provided your household income is within IRS limitations.

Deadlines: The deadline to do a Roth IRA conversion for 2017 is Dec. 31st, so you have some time. The deadline for making a 2017 contribution is tax day of next year. Let us know if you are interested in either and we can help determine if it makes sense to do so.

What's New With Us?

I will be traveling for work down to San Jose and San Francisco later next week, but will be available as always.

Have a great weekend,

Brian E Betz, CFP®
Principal

Market & Financial Planning Commentary

Hiring Falls But Employment Rises... Wait, What?!