Stock Market Correction Or... Something Worse?

/ Percension Wealth Advisors, LLC/

Last week was ugly for stocks. The good news is that the stock market rises over the long run. There is 100 years of history as evidence of that. The bad news is that in the short run there may be more pain in store before that happens. Let’s take a closer look.

The good news…

The S&P 500 index dropped -4.0% last week. Yes, this is bad.

The S&P has fallen in four of the past 5 weeks, down roughly -10.0% from its previous peak set one month ago. Yes, that is even worse.

But it might surprise you to learn that a stiff decline like this is fairly common. Here are similar instances over the past few years where the S&P fell -7.0% or more in the matter of a few weeks. These periods measure from peak-to-trough:

March 2018: -7.8%
Feb. 2018: -12.0%
Jan. 2016: -13.2%
Aug. 2015: -11.2%
Oct 2014: -10.0%
Oct. 2012: -8.3%
May 2012: -10.4%

Including this latest one, that’s 8 times in the past 6 years. So these types of price “corrections” happen more frequently than we might think. Following each of these occurrences, stocks rebounded in full within 3 months. The point is that, more often than not, the market finds its footing and eventually rallies higher, even if it takes a few months to do so.

This is no guarantee that stock prices will rally in a similar fashion again here, but recent history supports it. This is the optimistic view.

The bad news…

All 7 of the prior occurrences where stocks fell happened during a bull market. What if that run is over? What if this time is different?

That question is routinely asked when the stock market becomes choppy. Many expect that another recession is right around the corner. I have contended that another major stock market decline is most likely to occur when investors are collectively complacent, not when so many remain nervous or paranoid. I sense investors are more complacent today than one or two years ago, but complacent enough? I’m not so sure.

Going beyond the emotion and turning to what the data says, the price trends will ideally tell us whether we should believe this time is different and whether we think stock prices will continue heading south.

The first thing we want to do is analyze the long-term price trends. So we look to the monthly chart of the S&P 500. Looking back to the mid-1980s, I see similarities between today and five other years: 1987, 1998, 2000, 2007 and 2015. These are highlighted in the chart below by the vertical dashed lines colored either red or blue. Take a look:

(created in stockcharts.com)

Two things to point out from above:

(1) Of these 5 comparable points in time, twice the market rebounded within months and three times the S&P fell -35%, -50% and -58%, respectively, before rallying again.

(2) Momentum is building, but in a bad way. Meaning, there is growing momentum behind falling stock prices. We use Relative Strength (RSI) as an indicator to gauge this price momentum. It helps legitimize the price trend that we believe is forming.

As of Oct. 26th, the monthly RSI reading for the S&P 500 took a big drop from its recent highs and currently sits at 56.0. If that falls much below 50.0 history suggests that steeper losses are coming (at least based on the past 30 years of market history). Bear in mind that there are still three market days left in October. The final RSI reading at month-end is what matters most.

Looking at shorter timeframes, the weekly and daily price trends are concerning as well. The S&P 500 fell further below its 200-day moving average. Meanwhile, 65% of the stocks that comprise the S&P index are below their respective 200-day moving averages. That is the worst such percentage since Feb. 2016.

Okay, so now what?

Patience and poise.

Our process did a nice job last week. Given everything I said above, we will continue relying on our analysis to limit losses should the market fall further in the weeks ahead. Any portfolio changes are likely to be gradual, not wholesale. Most accounts have a sizable cash balance right now to help buffer against losses. We are not going to rush reinvesting those funds if it looks like the market is going to fall further. Cash is never where we prefer to be, but if it is what is best in order to protect capital, then we will.

Try not overreact to what happens in a given day, week or even month in the near future. The market is likely to remain somewhat volatile, so do not be surprised by big swings both up and down in the coming weeks. Even if the market rallies for a short time, those rallies can reverse quickly and often lead to even bigger losses.

No one wants to earn back losses quicker than I do, but we cannot, and will not, be hasty about it. Unless you plan on taking all of your money out of the market within the next few months, patience usually wins in the long run.

When market conditions do improve, there are three areas I will be looking to buy (as of now): Health Care, Utilities, Technology. I will spare the analysis on those until one-or-more of these come to fruition.

In The Market...

The S&P 500 fell -4.0% last week. Let's look under the hood:

(price data via stockcharts.com)

Another week where there was pain all around. The only exception was if you were invested in Treasury bonds, but that is moot because bonds have had a poor 2018 overall.

Some of the biggest companies reported quarterly earnings last week, including Amazon, Google and Microsoft. All three share prices dropped, despite those companies posting solid-or-better earnings. This shows that when the overall market is falling, it is very tough for a particular company to buck that trend. Apple and Facebook both report this week.

This is around the time that you will see opinions come out of the woodwork about what you should and should not do with your money/investments. By now you should know how I feel about the things that are said or written. My main advice is to be careful about who you take advice from. The last thing to do is become too emotional when the market gets rocky. Give me a call if you want to discuss anything that is on your mind. 

In Our Portfolios...

 

Have a great week!

Brian E Betz, CFP®
Principal

Trump's Tax Plan Has Holes, But Also A Good Shot Of Happening

/ Percension Wealth Advisors, LLC/

In The News...

Are major tax changes coming?

We got the first glimpse of President Trump's tax plan, and well, it told us a lot while telling us very little. Here are the notable changes:

CURRENT tax structure:

  • Income taxes: Today there are 7 different progressive tax brackets, ranging from 10.0% to 39.6%.
  • Standard deduction: $6,350 for individual tax filers and $12,700 for married couples who file together.
  • Itemized deductions: You can write-off many expenses, such as mortgage interest, donations and medical expenses exceeding 10% of adjusted gross income (AGI).
  • Corporate tax rate: 35% for C-Corporations.
  • Smaller biz tax rate: Varies for S-Corporation and Sole Proprietorship earnings as they flow through to the individual/family's personal tax rate.
  • Federal estate tax: 40% is applied to the value of assets left behind, if taxable estate exceeds $5.5 million.
  • Alternative minimum tax: AMT is paid by high-earners who receive what the IRS deems are too many deductions and exemptions.
 

TRUMP tax structure:

  • Income taxes: Reduced to 3 different progressive tax rates of 12%, 25% and 35%.
  • Standard deduction: Doubles to $12,000 for individuals and $24,000 for married couples.
  • Itemized deductions: Most deductions would be eliminated. Only home mortgage interest and charitable donation deductions would remain.
  • Corporate tax rate: Reduced to 20% for C-Corps.
  • Smaller biz tax rate: The maximum tax rate assessed on S-Corp and Sole Proprietorship earnings would be 25%, even if family rate is higher.
  • Federal estate tax: Estate taxes would be eliminated altogether at the federal level.
  • Alternative minimum tax: Similar to federal estate taxes the AMT would be eliminated altogether, without replacement.
  • Overseas income: Offshore income is given a one-time "repatriation" to come back to the U.S. at a low tax rate (currently, overseas income is only subject to foreign taxes).

Is the Trump tax plan good or bad? Unfortunately the devil is in the detail, which we do not have. We only heard what amounted to the positive tax changes, not the offsetting tax hikes or spending cuts likely needed to balance out the budget in future years. The argument will be made that economic growth will help subsidize lost tax dollars, channeling the age-old argument that...

Low taxes = More business production = Rising incomes = More gross income tax revenues

Is this true? I won't debate macroeconomics here. Besides, it may be a moot point anyway based on Trump's most probable path to passing tax reform. This path requires showing that his plan does not add to the federal deficit 10 years post-implementation. This refers to the "Byrd Rule", which essentially prevents laws from going into effect that will add to the nation's long-term debt. From what I have researched, Trump and the GOP would have to offset their various tax cuts with other sources of revenue (other tax hikes? budget cuts?) in order to comply with the Byrd Rule in the eyes of a non-partisan reviewer. Economic growth assumptions cannot be used as rationale to pacify the Byrd Rule. But we know darn well Trump will try to argue that, for better or worse.

So will tax reform happen? There is a legitimate chance it will, though like many people I am notoriously cynical and critical of Congress. This particular type of bill would only need a simple majority of 51 votes in the Senate rather than the normal two-thirds majority (60 votes). This has to do with the "reconciliation" clause that allows bills involving revenue, spending or the debt limit to pass with just 51 votes. This is a big deal because it simply means that a tax bill passes so long as all Republican senators approve it, rather than needing all GOP senators plus 8 Democrats to pass the bill. Republicans already control the House of Representatives, so any bill originating in the Senate would likely breeze through the House and quickly become law.

As for ensuring that any tax plan satisfies the Byrd Rule and does not add to the federal deficit 10 years down the road, it appears there are workarounds Republicans can employ. One option would be to sunset certain tax provisions as the 10-year mark approaches. Politically that would give the appearance of the "biggest tax cuts in history" while quietly allowing them to fizzle over time. Apparently this sun-setting technique was used 3 different times to implement tax laws under the most recent Bush administration.

A more likely scenario may be that there are, in fact, massive federal spending cuts or offsetting tax increases coming and Trump would rather let the air out of that balloon much more slowly.

So isn't tax reform a slam-dunk then? Like everything Congress does, it's complicated. Earlier this year Republicans applied reconciliation rules to the health care repeal/replacement. It seems because of that, some Republicans don't want to move forward with taxes until health care is completed. This led to the fumbled health care replacement vote back in July when the GOP could not muster 51 votes because a few Republicans (including AZ Senator John McCain) opposed it. Health care reform is priority to some Senate Republicans, who would prefer addressing that first before turning to tax reform.

(You might wondering... How did the health care bill qualify as a simple majority vote? Aren't the "reconciliation" vote rules reserved for budget-related bills only?

Great question. This is where I found myself digging way too deep into Congressional protocol. The best answer I have is that there is a disconnect between the spirit of the reconciliation rule and how it is used. Although the simple majority vote is technically reserved for budget legislation, many bills - including health care - can be argued to have budgetary consequence. If this is true, it seems like a slippery slope where more and more bills will avoid the normal two-thirds vote requirement over time because, well, what bill does not have budgetary consequences? This is a massive development considering Republicans could effectively pass any bill in the Senate if every one of the 52 GOP Senators are unified in their vote.)

One more roadblock: Additionally, a 2018 fiscal budget is necessary before tax reform can go to vote. While that should be easier since it will only need 51 Senate votes, we know it won't be. Similar to the failed health care vote, there is no guarantee that every Senate Republican will vote for whatever budget or tax plan is proposed. The longer this goes, the more fatigued Congress becomes and the longer everything drags on with little-or-no action. A movie we have seen before...

(Feel free to correct me on any of the above. Some of these procedures were news to me when I researched them this past week.)

In The Market...

The S&P 500 rose +0.7% this past week. Let's look under the hood:

(price data via Stockcharts.com)

STOCKS: The S&P 500 ended the third quarter with a bang, closing the week, month and quarter at a new all-time high of 2,519. For the week, 9-of-10 sectors were higher, which continues to be bullish entering what is seasonally the best quarter of the year. Our Utilities position was unfortunately the lone loser last week, but only down -0.3%. Our positions in Financials and Technology both outperformed the broad market on the week by a nice margin.

BONDS: Long-term interest rates rose for the third-straight week. As such, conservative bonds slid while high-yield bonds and investment-grade corporate bonds were up mildly. We continue to own investment-grade corporate bonds in most accounts.

We invested the cash we had been previously holding by repurchasing bond funds. One of those, long-term Treasuries (TLT), is one we sold a few weeks back. At that time I posted the following chart here:

(chart created via Stockcharts.com)

The first two notes on the above chart are what I wrote back in late-August. The shaded area highlights the weeks since then, showing how the price has fallen since we sold. We did so believing that Treasury bonds still posed a nice long-term opportunity. With the recent pullback I think bonds could be due to rally again. So we bought them again.

In Our Opinion...

Home prices appreciated +0.7% in July. Here are the notable price changes over the past year:

Seattle: +13.5%
Portland: +7.6%
San Francisco: +6.7%
National average: +5.9%

Seattle continues its reign as the hottest housing market, going on nearly a year now. Portland clings to its spot at #2, just ahead of a slew of major cities. This shows just how wide the gap is behind Seattle and everywhere else.

I often hear people say they will buy in the greater Seattle area when prices come back down. What they need to understand is that not everything that rises quickly in price is a bubble due to burst. I do think Seattle price gains will slow in the next 6-12 months, but prices slowing is far different from prices falling. I think San Francisco is a good reflection of this. Price growth in San Francisco ranks 9th among the 20 major cities in this latest S&P/Case-Shiller Home Price Index, whereas San Francisco was #1 for a very long time and was well ahead of the next-best city much like Seattle is now. I would suspect that Seattle will experience a similar arc.

But even if homes in Seattle appreciate at just 7% or 5% or even 3%, the point is they ARE rising. If you think timing the stock market is tough, good luck with real estate. Housing recessions do not come along often. In fact, 2009 is the only time over the past 60 years where prices definitively dropped. There were instances in the late-60's and early-90's where prices plateaued, but again, we're talking flattened prices not falling prices. I will side with history and say that, if anything, a price plateau is more realistic than a precipitous drop.

Here is a complete look at the monthly housing numbers by market:

In Our Portfolios...

Q&A/Financial Planning...

Quick comment in light of potential tax reform coming. If it looks likely that tax reform will happen and that new laws will dramatically impact how your investments are taxed (good or bad), we will work to make any necessary decisions before year-end.

I have not received any questions for a couple weeks. If you have any questions as it relates to financial planning, investing or our process, feel free to ask!

What's New With Us?

I will be trying to stay dry this weekend, with the exception of going to the Seahawks game this Sunday night.

Have a great weekend,

Betz Signature 250px.png
 

Brian E Betz, CFP®
Principal

Why September Is A Schizophrenic Month For The Market

/ Percension Wealth Advisors, LLC/

In The News...

This time of year is conflicting. Summer starts to wind down, but the holidays are here before we know it. Game of Thrones (my favorite show) ends but football season starts up, which fills my limited TV viewing void.

This same type of seasonal schizophrenia can be said about the stock market. September is historically a bad month for stocks. The S&P 500 index has been down in five of the past nine Septembers, including the past three. This is not to suggest doom on the horizon, but rather, September is simply a weaker month for stocks. The rub is, once we get through September we enter the strongest three-month period, October thru December, which is consistently the best market quarter of the calendar year.

Why is September historically weak? Tough to say. But a few factors may be in play to explain why it could be here... First, summer travel slows and more people are back to work, which means more computer time and thought about finances. This leads to greater buying and selling of stocks. Second, it's the last month of the quarter, which often comes with the volatility associated with quarter-end. Third, the S&P 500 is currently riding a nine-month winning streak that is at-risk of being snapped here in August, with four days remaining. That alone might lead some to think that the market tide is shifting downward and it is time to sell.

I do anticipate greater volatility in the weeks ahead, but for now the edge still goes to the odds that the market will rise heading into the end of the year. At least until the longer-term trend shifts, which it has yet to do.

In The Market...

The S&P 500 gained +0.8% last week. Let's look under the hood...

(price data via Yahoo Finance)

Stocks: The S&P 500 avoided a third-consecutive losing week. Most sectors followed suit, rising between 0.5% and 2.0%. The collective weekly rebound was nice to see, but will need to continue into next week to propel the S&P index back near/above its record high set back in July.

Bonds: Treasury bonds rallied for the fourth-straight week, with interest rates falling to the lowest levels since June. We currently own long-term Treasuries (TLT) within many client accounts. We are getting close to selling this holding but would like to see the price run another 1% or so higher before doing so.

As you'll see in the Portfolios section below, we bought a Utilities sector fund (XLU) following the sale of the Health Care fund (XLV). This allocation was made for most every client account, with the exact allocation ranging from 10% to 35%. Utilities possess arguably the smoothest, rising long-term trend among all major stock sectors. Take a look at the weekly chart of XLU here, which illustrates this upward pattern dating all the way back to 2010:

(chart created via stockcharts.com)

In Our Opinion...

As a business owner, a little paranoia is a good thing. It helps you stay focused on the day-to-day. It also helps you stay aware of competition and future risks without obsessing over them. As an investor, paranoia can paralyze you from putting money to work, but if harnessed properly can create opportunity.

The past 12 months is a great example of this. Every week someone voices to me their fear that the market will crash. In the past, as recently as the presidential election, I voiced my belief that the market tends to behave in contrast to what the consensus thinks will happen. There certainly is no consensus here that the market will fall, but the fact that it seems so many are waiting for it to do so has actually helped push stocks higher (the S&P is currently up +10% year-to-date).

Why?

My guess is this... When investors are nervous or fearful what do they do? Nothing, that's what. They don't invest, which means money stays on the sidelines. As time passes these investors slowly get back into the game, particularly as they see the market rise and fear missing out. It is not until a point of collective euphoria where we see big market drops or recessions.

Are we at that point of euphoria yet? No, I don't believe so. In addition to our daily statistical market analysis, I have yet to see/hear the behaviors from clients that suggest such excessive optimism. Frankly, I need to anecdotally hear about people pursuing speculative/ultra-risky investments, or a desire to load up on real estate -- things that are beyond their risk profile or financial means. Instead, I still come across people who appear ready to invest but cannot pull the trigger. For these reasons, I would say euphoria has not arrived.

In Our Portfolios...

Q&A/Financial Planning...

Are you able to save more OR in need of tax deductions?

Now is the time to adjust your retirement plan contributions to increase the amount you save/shelter from taxes between now and year-end. If you own a 401k (or like-account) through your work, review your contribution percentage and see if it is too low. A lot of people do not consider this until November, when it is too late to enact meaningful change for the current year.

Your contribution amount should not be as simple as, say, only putting in what your employer matches. For example, you may be under-funding your 401k if you take home considerably more income than you spend each month. Or, if you are frustrated by how much you pay in taxes each Spring. Conversely, you may be over-funding your 401k if you have considerable debt that you are having trouble paying down. The benefit you're getting by aggressively funding your 401k can get swallowed up by the interest payments tied to your debt.

If you plan to make IRA contributions, you have until April 15th of next year to do so for this current year. If you think your income could exceed the limit that prevents you from making tax-deferred contributions (or similarly, the limit that prevents you from making Roth IRA contributions), wait until the end of the year before making any deposits. Otherwise, you will have to remove those contributions in order to avoid an IRS penalty. Me or Gale are happy to help you figure out your savings abilities and limitations.

What's New With Us?

A few weeks ago I mentioned that I am looking to hire an Administrative Assistant. The target start date is Jan. 1st. I realize that is a number of months away, but just want to put out a reminder in the event you may know someone who is interested and qualified in the coming months. I am happy to provide a detailed job description upon request. This person will assist me directly and assume the duties of Chief Compliance Officer.

Have a great weekend,

Betz Signature 250px.png
 

Brian E Betz, CFP®
Principal