The Cost Of Business Just Went Up

The cost of business just went up. Literally.

Long-term interest rates reached a level not seen in over 4 years this past week. The 10-year U.S. Treasury bond yield hit 3.00% for the first time since Dec. 2013. Take a look:

(chart created in stockcharts.com)

As you can see it has been a long time coming, but something that has seemed inevitable since the start of this year when rates really started to trend higher. You can also see how low rates remain compared to 10 and 20 years ago (or 30 years ago when the 10-year yield exceeded 10%!).

What this means is that the costs to finance have gone up. Mortgages, car loans, student loans, lines-of-credit, etc. are all getting more expensive. This is a big reason why I recommended refinancing debt in 2016 and 2017 because this day would eventually come. Higher rates are not a bad thing -- actually the opposite. But it does mean we are now seeing real inflation take hold.

For years we have heard that inflation is a problem and that interest rates were about to skyrocket. Those have been utter myths. But today they are more of a reality. It is natural for inflation and rates to rise as the economy expands. The key is containing both so that they rise at a steady, sustainable pace. If they rise too quickly that is when we see shocks to various markets, as we did with housing in 2008.

Home prices rise: Speaking of real estate, home prices forged higher in February, rising by an average +0.4% nationwide during the month and +6.5% over the past year. Seattle impressively continues to lead all major cities, up +12.7% annually. Seattle homes also rose the most in February, up +1.7%. Six other cities saw home prices rise by more than +1.0% as well in February alone, including Denver, Detroit, Las Vegas, Los Angeles, San Diego and San Francisco. On a yearly basis, Seattle leads Las Vegas (up +11.6%) and San Francisco (+10.1%).

Here is a complete city-by-city look at the S&P/Case-Shiller housing report:

In The Market...

The S&P 500 was essentially unchanged this past week. Let's look under the hood:

(price data via stockcharts.com)

This past week was pretty dormant considering the biggest companies – Amazon, Google, Facebook, Microsoft – all reported first-quarter earnings results. In fact this time a quarter ago stocks began what resulted in a -10% market decline. The S&P index continues to float between the January record high and the February low.

It was a defensive week, with dividend-paying sectors leading the way (Utilities, REITs) while the more economically sensitive sectors (Materials, Industrials) were the worst performers. Long-term Treasury Bonds gained as well, despite the 10-year Treasury yield hitting 3.0%.

This type of activity is what I would expect to see amid stock market volatility. The overall market outlook did not change much from the previous week. I remain cautious, particularly as we get closer to the summer months, which tend to be bumpy for stocks. We are days from May, which carries the moniker “Sell in May and Go Away” for the tendency by investors to sell stocks and wait until the Fall to start buying again. There is some precedent for this looking back over the years, however last year bucked that trend as the market plowed higher throughout the summer.

We sold our Financials sector position (XLF) across all accounts that owned it. I do not like the movement within Financials over the past two months, which has been relatively weaker compared to some other sectors. To that end I believe there are better sectors to own, namely Energy, which we are looking to buy but will be thoughtful in doing so. We are content sitting on a cash position right now given how choppy the overall market has been. We will be patient and reinvest those funds in the future.

In Our Portfolios...


In Financial Planning...

As Summer nears and the housing market heats up, I know a lot of people who are revisiting the same conversation from a year ago:

Do we sell our house and buy something new, or, do we remodel?

Many of these people are in a better financial situation than they were a year ago, so in a vacuum it may be enticing to buy a more expensive home or to pump money into their current one.

But should it be?

Consider some key differences from a year ago. Unless you are downsizing the next home is only going to be more expensive, so any additional equity you have built up over the past year will be necessary toward the new home. Second, as mentioned, interest rates are higher today. So if you end up with a mortgage balance that is bigger than what you currently have, not only will your monthly payment be bigger but your interest payments will increase. Finally, if you go the remodel route, be aware that contractors are likely more expensive and less available than in recent years. Also, unless you are paying for the remodel with cash, your line-of-credit will come with the same aforementioned financing costs.

It is important to know how the different markets have evolved, especially at a time when housing values are slowly leveling off and financing costs are really starting to rise.

What's New With Us?

As a reminder, I will be out of the office on vacation Monday through Wednesday next week. If you need me I will be available remotely, but may not be quick to respond.

Have a great weekend!

Brian E. Betz, CFP
Principal®

An Old Saying Rings True Yet Again

Top Of Mind...

There is an old saying among certain professional investors: "The news follows the price."

What it means is, by the time the news breaks to explain why a certain stock price or the overall market moved up or down it is already past tense. This is mostly the case with the broader stock market though than it is with individual stocks, as individual companies are prone to gyrate higher or lower immediately following the release of their quarterly earnings results. Most of the time the broader stock market will already be rising when good news arrives, or already falling when bad news hits.

Now it seems to be happening again within the bond market. Bond guru and former PIMCO-Founder Bill Gross said this week that we should expect a mild bear market for bonds. Specifically, he referred to U.S. Treasury bonds, which are traditionally the safest and most conservative of all bond classes.

The thing is though, Treasury bond values have already been falling for the past five months. Long-term interest rates have simultaneously risen because bond values and their interest rates move opposite one another (a frequently discussed concept that I won't detail here but am happy to explain).

I have written for the past two months that the Treasury bond market was on shaky legs. I derived that opinion from our own price analysis, which started months ago. The fact that a famed bond investor like Gross muttered the words "bear market" are not reasons to justify investment decisions you might make, despite the fact that his expertise carries weight when he speaks.

It is not that I necessarily agree or disagree with Gross' assessment. I have felt that the Treasury bond market has been in trouble for a while, but I refrain from using the words "bull market" or "bear market" in general because they have become such ambiguous terms.

Gross went on to say that he favors investment-grade corporate bonds, which are an asset class that look relatively appealing when compared to Treasuries but are still fledgling a bit as we speak. I am glad he mentioned that though because it helps reiterate that not all bonds are created equal -- a popular myth that needs to be expelled. Corporate bonds differ from Treasury bonds. Investment-grade bonds differ from high-yield bonds. Short-term bonds differ from longer-term bonds. So on and so forth.

For more proof that news follows price, look at 2002 or 2008. During the "dot-bomb" era the worst year of stock market returns was 2002. Yet, leading up to that year the market had already fallen some -25% between the summer of 2000 and the end of 2001. But it was not until unemployment picked up in late-2001 that the news stories started rolling in.

When Lehman Brothers declared bankruptcy in Sept. 2008 the U.S. stock market had already lost 20% in the 10 months preceding that event. Did the market worsen from there? It sure did, but stock prices were already on the decline for quite some time before that point.

These are just a couple stark instances that may help explain why our investment management approach focuses almost entirely on price movements, rather than product launches, press releases or someone else's research report. Supply and demand are the only aspects that matter when it comes to analyzing market movements and the purest reflection of supply and demand is price.

This may help explain why I am often ambivalent when asked what I think about a particular business when it makes news. It isn't that I am uninformed, it is just that the news does not matter much to me because by the time it comes it is in the past. Yesterday's news, if you will.

In The Market...

The S&P 500 gained +0.6% this past week. Let's look under the hood:

(price data via stockcharts.com)

It was a choppy few days that needed a big Friday to finish positive for the week (and did). Most sectors were higher while the defensive ones, namely Consumer Staples and Real Estate, were down.

Technology is easily the best-looking sector heading into next week, but for tech stocks to continue to lead they will need to surpass their previous price highs that many of them set in late-January. The same goes for the entire market as a whole via the S&P 500, but the S&P is still more than 4% away from its record high, whereas the Tech sector is within striking distance of its all-time high. Technology may hold the key for the broader market.

Bonds were negative again and have fallen in seven of the last 10 weeks dating back to December. The 10-year Treasury bond yield is knocking on the door of 3.00% but it has yet to rise that high. I think that is where interest rates will run into some resistance if history has anything to say about it. I could envision bonds rallying some point soon, even if it is temporary.

This chart of the 10-year Treasury yield (interest rate) shows why:

(created in stockcharts.com)

Notice in late-2013 that interest rates made a sharp U-turn when the yield reached right about 3.00%. This is certainly no guarantee that history will repeat itself, but if it does, bonds would benefit in the interim. I suspect that rates will pull back a bit if/when 3.00% is reached before ultimately rallying higher.

In Our Portfolios...


In Financial Planning...

Going through open enrollment at work?

If so, this is a reminder that we are happy to review your employee benefits options as it relates to deciding between health care plans and any flexible spending accounts your company offers. These choices are often complicated and confusing, especially Health Savings Accounts (HSAs). I would suspect that HSAs will slowly replace more traditional PPO options over time. If you want help understanding your HSA, let us know.

What's New With Us?

In light of the snowfall we had the past few days I will be trying to stay warm while finishing up my latest house project -- installing new flooring in our laundry room. Also, next week I will be out of the office most of Thursday and all day Friday, so the weekly blog may be delayed until the following Sunday or Monday.

Just so I don't forget, our new office address effective March 1st is:

801 2nd Ave Suite 800
Seattle, WA 98104

I will provide my new direct line phone number when officially moved.

Have a great weekend,

Brian E Betz, CFP®
Principal

Are Interest Rates About To Explode Higher?

Top Of Mind...

Interest rates hit a high this past week that we haven't seen in 4 years.

The 10-year Treasury yield climbed to 2.64% this week, which is higher than it has been at any point since 2014. This is the annual interest rate an investor would earn if they bought a 10-year U.S. Treasury bond today. Take a look...

(chart created via stockcharts.com)

This is a pretty important development given that long-term rates have failed to get back to pre-recession levels ever since 2009. As the above chart shows, in the past five years rates have quickly fallen anytime they approached a certain peak (the pink, dashed line). The same fate could happen again here, but I suspect we may finally start to see real increase in long-term rates after a decade of dormancy.

What does this mean? There are a few implications if long-term rates do, in fact, move higher. For one, it means bond values will go down. Second, it could spell more positive returns for the Financials sector, as banks and other firms that lend generally benefit from higher interest rates. Third, it means more expensive financing for things like home mortgages and car loans.

How this affects us: As you know, most accounts own some amount of bonds to help diversify from stocks. We would likely migrate away from Treasuries or other bonds that possess similar characteristics, such as investment-grade bonds, which we sold this past week. It could mean sitting in cash for a period of time in the event there isn't another type of bond we feel is worth owning.

We continue to own high-yield bonds in most accounts, which are a very different breed than Treasuries. I suspect high-yields will not be immune from an increase in Treasury rates, but the negative impact on high-yield bonds should be dulled compared to "safer" bonds like Treasuries.

We will continue our analysis, see what the next week brings and act accordingly.

In The Market...

The S&P 500 gained +0.9% this past week. Let's look at how the individual sectors performed:

(price data via stockcharts.com)

Another week of gains for the S&P 500, which is quickly up +5% in just three weeks to start the new year. This most recent week was more flawed though, as four of the six sectors were negative on the week. Two sectors we are looking to buy next week are Financials (XLF) or Consumer Staples (XLP). Financials continue to trend nicely higher, while Consumer Staples appear on the cusp of a new rally.

As alluded to earlier, it was another down week for Treasury bonds, which fell for the 3rd-straight week. If bonds are going to fight off this rise in interest rates then investors will need to show up soon ready to buy.

We will likely make some modifications to our bond fund lineup as well in the coming weeks. TD Ameritrade amended their list of commission-free funds, which are the ones we try to use when appropriate. I have to dig in and research the new list, but if you have any questions feel free to ask. My hope is to find a buffet of funds that are comparable to the previous ones and use those so-as to escape incurring transaction costs.

In Financial Planning...

There is one change within this year's tax reform that I had not previously touched on but is probably worth mentioning. The ability to "recharacterize" a Roth IRA conversion is no more.

A Roth IRA recharacterization is the act of undoing a Roth conversion (something I wrote about a few weeks back here). It reverses the process of having turned a Traditional IRA into a Roth IRA, and along with it reverses the tax burden you would be subject to pay on the balance converted. Many people do this if, for example, their income ends up being much higher throughout the year than they anticipated. They would rather wait for another year than pay a higher tax percentage now on the converted amount.

The old rules allowed you all the way until Oct. 15th to undo a Roth IRA conversion that stemmed from the previous tax year. Now, you cannot do them at all. I highlight this particularly because we will sometimes recommend that clients convert a portion (or all) of their tax-deferred IRA balance into a Roth, whether because they are having an unusually low earnings year or because it simply makes sense to have those funds grow tax-free. Moving forward, there are no do-overs once that decision is made.

In Our Portfolios...


What's New With Us...

I will be ramping up my hiring search for a Chief Compliance Officer in the coming weeks. If you are curious to know more about the position or what I am looking for in a candidate, just ask.

Have a great weekend!

Brian E Betz, CFP®
Principal

The End Of Neutrality And Weighing The Final GOP Tax Plan

In The News...

December is normally a slow news month, but for whatever reason a ton of stuff has transpired recently.

Net Neutrality no more: The Federal Communications Commission (FCC) voted 3-2 in favor of repealing the Net Neutrality laws that were enacted during the Obama administration to prevent internet service providers like Comcast or AT&T from giving preference to certain websites over others. Neutrality laws ensured that those providers allowed all internet traffic to flow equally and freely. This includes everything from a web page to an email service to Facebook, YouTube, etc.

As best I understand it, the argument in favor of eliminating Net Neutrality is that these internet broadband providers would be forced to improve their existing systems/services. The argument against it is that providers will increase their prices or provide preferential internet speeds to certain sites, such as those operated by sister-companies. For example, Comcast owns NBC and could allow NBC content to stream quicker than content from other, comparable news outlets. Internet providers could block certain content or charge more to access content. In short, higher prices to consumers. This graphic sums it up:

(photo created by Alphr.com)

Interest rates going up: The Federal Reserve raised its benchmark lending rate, the Federal Funds rate, from 1.00% to 1.25%. The last Fed Funds rate increase was in June 2017. Two of the nine Fed committee members opposed this latest rate increase, which is telling for future meetings. I would anticipate we do not see another rate hike for at least six months based on some level of dissent over this latest rate increase.

Bonds rallied off the news. On a related note, this was Fed Chair Janet Yellen's final press conference before Jerome Powell takes the helm in Feb. 2018. I would suspect there will be some choppiness in the bond market as that transition takes place. I recall that being the case when Yellen took over for former Chair Ben Bernanke, as she quickly learned that her words and tone carried great influence over interest rate expectations among investors.

Yellen responded to a question about Bitcoin, calling it a "highly speculative asset". She said the Fed has no plans to pursue regulatory measures given Bitcoin's currently insignificant role as a form of payment. Keep an eye on this because Bitcoin will invariably be pulled into the political discourse, whether regulatory steps can be taken or not.

Tax reform done? Republicans issued the final version of their tax reform plan. For my thoughts on this check out the OPINION section below.

    In The Market...

    The S&P 500 +0.9% this past week. Let's look under the hood:

    (price data via stockcharts.com)

    The S&P 500 rose for the 4th-straight week. With only two weeks left this is setting up to finish as the best market year for U.S. stocks since 2013. Momentum continues to favor this bull market on all three time frames we analyze: Monthly, Weekly and Daily trends.

    Technology rebounded nicely last week and is a position we added for most client accounts (XLK). We sold our Consumer Discretionary sector fund (XLY), which was mostly due to preferring other certain that we will look to purchase. Financials and Health Care are the primary targets we are looking to buy.

    Santa Rally coming? I would suspect that things will be a bit choppy right around year-end, as investors take capital gains tax planning into consideration. However, the seasonally bullish "Santa Rally" could help push stock prices even higher. This 7-day period, should it occur, would be the last five trading days of December, plus the first two days of January.

    In Our Opinion...

    Republicans unveiled their final tax reform plan, expected to be signed this week. Here are the highlights:

    • Income tax brackets are slightly lowered across the board, but seven different brackets remain (shown in the graphic below). Remember that income taxes are progressive, meaning that different segments of your income are taxed at different rates. For example, if you are married and have taxable income of $200,000, the first $19,050 is taxed 10%, the middle amounts are taxed 12% and 22%, and the final $35,000 is taxed 24%.
    • The standard deduction doubles from $6,350 to $12,000 for individual tax filers and from $12,700 to $24,000 for married couples.
    • Personal exemptions are eliminated. You can currently deduct $4,000 for you, your spouse and any dependents (e.g. kids) you can claim.
    • The limit on home mortgage interest is reduced. Currently, you can deduct interest tied to a maximum $1 million mortgage loan. Moving forward you can only deduct interest related to up to $750,000 of mortgage debt.
    • The mandate that everyone must purchase health insurance is eliminated.
    • Corporate tax rate for C-Corporations is reduced from 35% to 21%.
    • A one-time, lower repatriation tax rate is applied to U.S. companies with foreign operations who bring cash and other assets back to the U.S. Right now those companies are only taxed when they bring profits and assets back to the U.S. To encourage them to come home, companies will be taxed 15.5% on cash assets and 8% on non-cash assets.
    • Small businesses like S-Corporations and LLCs, where income passes through to the owner's individual income tax return, will get a 20% deduction on such income. Service-based businesses that earn more than $315,000 would not receive this deduction.
    • 529 college savings could be accessed, tax-free, for K-12 education expenses.

    Tax reforms I like: I like the reduction to corporate tax rates and the deduction for small, pass-through businesses. I really like that 529 college savings will be extended to pre-college education. I also like that, contrary to prior proposals, the student-loan interest deduction remains in tact.

    The aforementioned 20% deduction for pass-through businesses is one that will garner a lot of debate. It is an attempt by lawmakers to help small businesses amid reducing the corporate tax rate from 35% to 21%. I am obviously bias, but I am all for giving a boost to small business owners.

    However, there is a concern that entities will be created simply to take advantage of this deduction, specifically because of wages. Instead of workers earning wages as employees this could compel them to "leave" their employer, set up a pass-through entity and then get rehired as a contractor by that same employer. This would allow the worker to have their previously paid wages now show up as consultancy fees (or some term other than wages/salary) and flow through the income statement of their business. Those earnings would flow to the bottom-line, and thus, be eligible for the 20% deduction.

    Tax reforms I dislike: I have less of an issue with what was done than I do with opportunities missed. The various income tax brackets were reduced, but not my much. I do not see it resulting in "the biggest tax cuts in history", but because the rates were reduced at all, the plan will be marketed as such.

    The promise of over-simplifying the tax code was a broken one. The tax plan does little to simplify anything. Simplifying the tax code would be to enact a flat income tax, or at the very least, cut the number of tax brackets down to three or four.

    The standard deduction is doubled, but personal exemptions are eliminated. That seems to be largely an offset, though big families who itemize their deductions will suffer most. They lose the personal/dependency exemptions (previously a deduction of $4,000 per-family member), yet won't benefit from the standard deduction increase because they itemize their deductions.

    I certainly do not like the fact that the Joint Committee on Taxation estimates that this tax plan will add $1.5 trillion to the budget deficit over the next decade. But, I will leave it to others to debate the budgetary consequences.

    In Our Portfolios...

    Q&A/Financial Planning...

    'Tis the season to consider a Roth IRA conversion! If you own a tax-deferred IRA or 401(k), check out my latest blog post detailing how a Roth IRA conversion might benefit you in retirement. I describe what a Roth conversion is and some different circumstances that influence this decision. I encourage you to read it here.

    What's New With Us?

    I will be out of town for Christmas from Friday (Dec. 22nd) to the following Wednesday (Dec. 27th). Those two dates are specifically the days we are flying, so my availability will be limited. I will be working remotely while gone and should be available in between those dates. I likely will not write a blog this week, so if I do not talk to you -- Merry Christmas & Happy Holidays!

    Have a great week,

    Signature.png
     

    Brian E Betz, CFP
    Principal®

    How The Federal Reserve Will Make $4 Trillion Disappear

    In The News...

    Nine years later, it appears the day has finally come.

    The U.S. Federal Reserve will begin to reduce its balance sheet by reversing the quantitative easing (QE) stimulus measures that began in the wake of the 2008 recession. For the past decade the Fed has been buying Treasury bonds and mortgage-backed securities, which has consequently injected new money into the U.S. economy. Such liquidity actions are implemented to promote lending/borrowing between banks and consumers during periods when the economy slows.

    What makes this Fed decision unique? What makes QE so unprecedented is that it has been going on for nearly a decade, to where the Federal Reserve balance sheet now holds $4.5 trillion in Treasury bonds and mortgage-backed securities. To begin the unwinding process and shrink its balance sheet to a more normal level, the Fed will let $10 billion of bonds mature and roll-off its balance sheet each month moving forward. That amount will gradually increase to the tune of $50 billion monthly.

    What about interest rates? This announcement came following the latest Federal Open Market Committee (FOMC) meeting this past week. The Fed opted to hold off on interest rates, keeping its benchmark federal funds lending rate at 1.00% rather than increasing it to 1.25%. The committee expects to increase rates once more in 2018. Fed leaders meet twice more before the end of the year.

    The decision to roll back QE means the Fed must feel comfortable regarding its two goals:

    1. Maximum level of employment
    2. Annual inflation growth of 2%

    The first goal is open to interpretation. The official unemployment rate is 4.4%, which has improved substantially from when it peaked at 10% in late-2009. A sub-5% unemployment rate appears to be within the Fed's target range, but that is hard to tell. The second goal of 2% inflation is also within range despite the fact that the Fed itself reduced its inflation expectations over the next two years.

    What do I think of the Fed's decision and what does it mean to investors? See the OPINION section below.

    In The Market...

    The S&P 500 was fractionally up +0.1% this past week. Let's look under the hood:

    (price data via Yahoo Finance)

    STOCKS: The S&P index was essentially flat, so it comes as no surprise that the sectors were nearly split between winners and losers. Interest-rate sensitive sectors were the biggest movers, which is also no surprise amid the Fed announcement. Financials were the largest gainer while the dividend-heavy Utilities and Real Estate sectors were the worst performers. This week was a net-negative for us, because despite the fact that many client accounts own Financials, all accounts own Utilities.

    BONDS: The bond market followed suit, although interest rates did not rise as much as you might expect in light of the Fed news. We are still sitting on a chunk of cash in most client accounts, ready to deploy it once bond market conditions oblige.

    In Our Opinion...

    What does the historic unwinding of QE mean for the market and investors? Right now, not much. But let's first remind ourselves how we got here...

    The Fed has two jobs: Monitor inflation and manage liquidity. Said differently, ensure that prices of goods and services do not rise too quickly or fall too sharply, while also ensuring that there is the right level of cash in the economy to promote steady lending/borrowing. The latter is precisely what QE aimed to accomplish. When the economy slows and both businesses and consumers turtle-up from spending, liquidity becomes an issue. Bond-buying programs help combat that by pumping new cash into circulation. As we have seen though, deciding when to turn that off is challenging. The Fed has taken a lot of heat for not unwinding QE sooner. To be honest, I do not know if this is the right time or whether it should have happened before now. Hopefully the market is stable enough to consume this gradual monetary tightening process.

    Which brings me back to what this means to investors... The stock market has moved higher over the past year without much volatility, which is just the way we want it. This needs to continue or else the Fed could deviate from its plan. We would expect interest rates to creep higher as well as the Fed raises short-term rates and as investors prefer stocks over long-term bonds (remember, weak bond demand means falling bond values, which means rising interest rates).

    But if there is one thing we know, the market is unpredictable. For years the herd mentality believed that interest rates would spike. If you turned on financial news you would hear that over and over. Let me be clear...

    That simply never happened.

    Yes, rates have risen over the past year. But these rate increases have been tepid and have occurred long after the time when "experts" predicted. The fact also remains that long-term interest rates will ultimately be determined by how investors react to the health of the stock and bond markets over time. If stocks fall in a sharp or prolonged manner I would bet that investors flock into Treasury bonds. This would send bond values up and interest rates down.

    In Our Portfolios...

    Q&A/Financial Planning...

    A reminder for those of you who are self-employed! Next week is your last chance to set up a Simple IRA for 2017 if you want to contribute this year. If taxes are a concern and you are able to contribute more than the $5,500 Traditional IRA annual limit, consider setting up a Simple IRA where you can contribute $12,500 (or $15,500 if you have reached age 50).

    There are other considerations though, namely the requirement to match what your employees contribute. Also, consider the long-term viability of the retirement plan and whether the parameters and restrictions of a Simple IRA align with where your business is headed in years to come. If you already have a Simple IRA plan then this deadline is moot. If you have a Simple IRA and feel you can contribute more than $12,500 for the year, consider graduating to a 401k plan. I am happy to expand on any of this, just ask.

    What's New With Us?

    As of Sept. 18th TD Ameritrade and Scottrade are now one, joint company. You may receive some notification on this, but no action is required. I expect that your tax forms for 2017 will be consolidated between the two custodians to ensure seamless Form 1099 tax reporting.

    Have a great weekend!

    Betz Signature 250px.png
     

    Brian E Betz®
    Principal

    Market Hits A New High As "Sell In May" Arrives

    In The News...

    Interest rates held - The Federal Reserve did not increase its target lending rate (Federal Funds Rate), opting to keep it at 0.75% rather than increase it to 1.00%. Language coming out of the Fed's meeting last week was apparently enough to boost expectations that a rate increase will occur in June. The Fed likes to telegraph its moves, so I would be inclined to believe it. The most obvious impact these actions have are on short-term savings or loans, as those rates most closely mirror the Fed's actions.

    Apple is cash king - For all the crap that Apple received in recent years for failing to innovate, we should admire their fiscal responsibility. Apple is notorious for hoarding cash, which has begged the question of what they would do with it. In the quarterly earnings call Apple announced a 10% dividend increase. The new, total dividend Apple will pay annually, $13.2 billion, is more than one-third of the companies in the S&P 500 are worth. Here is the full story.

    Know your Social Security - A recent article in Time showed that fewer people are tapping Social Security retirement benefits when they first come available at age 62. The survey of 61-year-olds, done by Fidelity, found that 28% planned on taking early benefits, compared to 45% back in 2008. Of course the economy was on the cusp of recession back in 2008, but the decline is still encouraging. The closer you get to age 62 or your normal retirement age (which is 65, 66 or 67 depending on the year you were born), be aware of your options as they are nuanced. It is important to maximize your payout in retirement.

    A lifeline for landline? A government study found that 46% of U.S. households have landline phones. I am not sure if this number is more or less than I would expect, but it's interesting. 50% of homes have cell phone service only.

    In The Market...

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

    (data source: Yahoo Finance)

    Stocks: Financials and Technology led the way, rising more than +1.0% apiece. Real Estate and Energy were again the lagging sectors. We own Real Estate (VNQ) in certain accounts, and while I do not like the short-term movement within the sector I remain bullish about the long-term view. The Real Estate fund we own also pays a 4.4% dividend, which helps soften the blow of a couple down weeks.

    New high: The S&P 500 closed just shy of 2,400, marking an all-time high that eclipses the previous high set back in February. This matters for a couple reasons. First, all-time highs are bullish. Second, the S&P index does not account for dividends, which makes a new high look even better. This sets up pretty for well for the coming weeks, although the summer months do pose some risk (more on this in Opinion below).

    Bonds: We did not learn much last week about the bond market. Most bond types were slightly negative, while preferred stock (we treat as a bond) did squeak out a small weekly gain. I still think Treasury bonds (TLT) will rally sometime soon. This would mean lower interest rates, as most predict rates to continue moving higher.

    Here is why... Below is a chart of a widely owned long-term Treasury fund (TLT). This current point in time sure resembles late-2013 and late-2015, periods right before the bond market staged a massive rally. Take a look:

    (chart created via stockcharts.com)

    To be clear I don't think Treasuries are a "buy" just yet. But we are close. It doesn't seem right that bonds would take flight again after years of historically low rates. Popular opinion believes rates will continue to rise, not fall again. However, the data is what it is. History suggests long-term bonds may become very appetizing in the near future.

    In Our Opinion...

    May has arrived, bringing with it the popular question: Sell in May and go away?

    This refers to the seasonal investing strategy of selling stocks this month, in anticipation that the market will tumble. While there is not a ton of statistical merit to support selling in the month of May, it really speaks to a broader seasonal trend that stocks perform much better in the fourth and first quarters, October thru March, than they do the second and third quarters, April thru September. (You will have to take my word on this -- I'll try digging up the specific stats in a future post. It is stark how superior Q4 and Q1 are compared to the rest of the year.)

    So, should we care about "Sell in May"? No, not really. For one, the market remains strong on a long-term basis, as defined by looking ahead in weeks and months. Second, if we did see a sell-off I would still be looking for opportunities to invest, most likely in defensive stock sectors and bonds. Third, and most importantly, I do not think buying or selling based on a seasonal trend alone makes for much of an investment strategy.

    Market volatility does tend to increase during the summer. Kids are out of school so families are on vacation, and thus, market activity slows. This gives sellers a bit of control. We will continue to evaluate market trends and adjust accordingly, as we always do.

    In Our Portfolios...

    Stocks: No changes last week. I really like the Industrials sector (XLI) right now, but do not feel it is worth selling any of our key stock positions to buy XLI just yet.

    Bonds: No changes last week. I remain bullish preferred stock (PFF) and high-yield bonds (JNK), two of our current holdings.

    Q&A / Financial Planning...

    What do I need to do about my TD Ameritrade account?

    A few of you have asked about next steps regarding TD Ameritrade. The answer is nothing. I will send you one more Docusign email that contains the transfer request, to move your account(s) from Scottrade to TD Ameritrade. Once that is complete I will provide log-in instructions for you to view your TDA account. I anticipate most accounts transferring over to TDA toward the end of this month.

    For taxable accounts (namely non-IRA accounts), the cost-basis information will transfer over soon after your holdings do. This should result in receiving just one Form 1099 at year-end. Traditional IRA accounts do not need to worry about cost-basis information, as only withdrawals are taxed. Roth IRA accounts do not need to worry about either.

    Let me know if you have questions.

    What's New With Us?

    I am mixing things up a bit. I am going to start sending these weekly recaps on Friday, as opposed to Monday. That way, for those of you who regularly read these, the market-sensitive information will be as real-time as possible. For those of you who occasionally read these but only as work/life accommodates, perhaps the weekend will present a bit more opportunity to do so. And for those of you who never click through to read these, well, you will not be reading this anyway... :)

    I am always interested in your feedback -- what you like or dislike, topics you would like me to discuss more, the day of the week or time of the day you prefer getting these, etc.

    Have a great weekend,

     

    Brian E Betz, CFP®
    Principal

    Worst Week Of 2017... What's Next?

    In The News...

    If the past year has taught us one thing, the narrative matters. Lets use last week as an example:

    The market had its worst week of the year, sliding -1.3%.

    or...

    The market slipped a little more than -1%, just the third weekly loss of 2017.

    Two opposing ways to explain last week. Each portraying a different story. When we want or expect something to turn out a certain way, that anticipation shapes our evaluation of it. I say this because people continue to wait for the market to face-plant. A number of clients and non-clients have said as much to me over the past month. So when the market strings together a few losing days the chirping becomes louder and angst rises.

    Here is the reality: It is common for the stock market to fall ~10% (or more) at some point every year. Keep that in mind, especially coming off a week when the market was down roughly -1%. I have said for a few weeks that I wouldn't be surprised to see the S&P 500 flatten out, but that does not mean the sky is falling.

    In The Market...

    The S&P 500 was down -1.3%. Let's look under the hood:

    (data source: Yahoo! Finance)

    It was a crummy week for most stock sectors, evidenced by the sea of red above. Utilities, arguably the most defensive sector, were up more than +1% and is a sector that I would like to add in the near future (some portfolios already own it).

    Remember what I said in my last post about how long-term interest rates behave after the Federal Reserve raises short-term rates? If you don't, here is a reminder... What I showed was how long-term interest rates actually fell the previous two times the Fed raised rates. Sure enough, following the Fed's third rate hike rates declined yet again due to increased bond demand.

    Bonds had a nice week as a whole. This often occurs when stocks are down because investors sell stocks and buy bonds (hence the increased bond demand). It is also a bit ironic that Financials were the worst stock sector, considering that financial stocks would seem to benefit most by the Fed rate hike, but lets not beat a dead horse...

    In Our Opinion...

    The market is essentially always open, Monday through Friday, when you consider overseas markets and the trading activity that happens within the U.S. market outside of normal hours via the "futures" market that opens at 5 p.m. PST. I bring this up because the U.S. market opened this new week nearly -1% lower than it finished last week, and with it came references connecting the market loss to investor fear surrounding health care reform and the latest bill that flamed-out last Friday.

    Simply put, that is B.S.

    It is a nice alibi, but it is wrong. To my earlier point, any potential market declines that occur in the near future may just be due to the fact that the market does not go up 100% of the time. If you are positive about the market then any declines might present a good buying opportunity. If you are negative about the market then you certainly did not arrive at that conclusion because of the vote surrounding a health care bill (I hope).

    Bad news travels faster than good news, so be prepared for big, scary headlines if the market remains choppy here for a bit. There will be all sorts of explanations that try to reason with what occurs. This is not to say that we won't feel the need to sell or become more defensive. But it does mean that we will rely on our disciplined approach in making such decisions, tuning out the noise and allowing our analysis to guide the way.

    In Our Portfolios...

    Stocks: No changes last week.

    Bonds: We added preferred stock (PFF) to certain accounts. Due to the risk characteristics of preferred stock, we treat this asset class as a bond for portfolio allocation purposes because it tends to be a happy medium between common stock and more conservative types of bonds.

    Q&A / Financial Planning...

    I had an interesting conversation last week with my friend & colleague Phil Painter of North Pacific Mortgage. Phil has come across an increasing number of new clients who have interest-only mortgages or lines-of-credit. We speculated why this is and arrived at two conclusions:

    1. Many interest-only mortgages/debts were the result of challenges posed by the 2008 recession.
    2. Conversations about interest-only loans are resurfacing over concern that the string of recent Fed rate hikes will cause these adjustable rates to balloon.

    Even if the second conclusion does not materialize, do not be lulled to sleep by your mortgage, particularly if you are in an interest-only loan. We preach that financial goals are unique, but paying off your mortgage - for most people - is one that deserves a plan. If you are only paying interest then it becomes tougher to build equity (unless you are effectively leveraging your money by investing funds elsewhere, which few actually do). More importantly, you may delay the principal pay-down into retirement, a time when most want to limit expenses to accommodate other things, such as health care or travel.

    It is easy to overlook the bigger picture. Life gets busy and we get into routines. If you own an interest-only loan, even if it is a smaller line-of-credit, tackle it head-on today. If you want a professional opinion, I highly recommend Phil Painter. He is a great guy and someone I trust immensely. Contact us if you would like an introduction, but at the very least explore your options to learn how a refinance could benefit your long-term financial plans.

    What's New With Us?

    We will begin migrating to TD Ameritrade in early/mid April. Gale or I will be in touch regarding the forms we'll need to complete. We will make the transition as smooth as possible.

    Have a great week everyone!

     

    Brian E Betz, CFP®
    Principal

    Fed Raises Interest Rates - What It Means And How Fed Policy Is Misinterpreted

    In The News...

    To my surprise, #3 came earlier than I expected.

    The Federal Reserve raised interest rates for the third time since it began "normalizing" rates back in Dec. 2015. This latest rate increase was another quarter-point rise in the Federal Funds Rate, boosting it from 0.50% to 0.75%. Following 7 years where rates were essentially 0.00% the Fed has begun slowly increasing them. Here is a look at how historically the Fed Funds Rate was:

    (source: Federal Reserve Bank of St. Louis)

    I emphasize Fed Funds Rate because people err by ambiguously saying "rates" anytime they refer to Fed policy. It does not represent all interest rates. The Fed Funds Rate is the short-term lending rate set by the Fed, which big banks use to lend to one another. That target rate trickles down and ultimately steers the interest rates banks apply to savings accounts and short-term loans. But there are two pretty big misconceptions about Fed policy in relation to interest rates, which I detail in the Opinion section below.

    The Fed has two jobs: Manage our money supply and manage inflation. Raising interest rates is one way the Fed strives to temper inflation. In textbook economics terms, the Fed will raise rates as the economy expands. This promotes steadiness and prevents economic overheating, or worse, market bubbles. In 2008 we saw the reverse, where the Fed aggressively lowered interest rates in order to encourage lending and borrowing at time when the economy needed it to stave off recession.

    Few entities have a tougher job than the Fed. Amidst the NCAA Tournament games happening right now the Fed is like a referee, where doing a good job is defined by making the calls everyone expects while remaining largely unnoticed. The only difference is that even if the Fed makes what appear to be the right calls, such as whether to raise rates, it's popular to go back and blame Fed officials if the market does not respond as anticipated. The Fed has an immensely tough and thankless job.

    In The Market...

    The S&P 500 gained +0.2% last week. Let's look under the hood:

    Most sectors were positive last week, yet the S&P 500 was up minimally as a whole. Bonds and dividend-heavy stocks fell leading up to the Fed announcement as it was presumed that interest rates would go up. Investors do not like owning bonds if they believe they can obtain a higher interest rate in the near future. The funny part is that investors jumped back into bonds and dividend stocks immediately after the Fed announced the rate hike at 11 a.m. last Wednesday.

    There is meaningful context relating to how long-term interest rates react following Fed rate hikes. Below is a chart of the 10-year Treasury yield, which differs from the short-term Federal Funds rate, but is more relevant when talking investments. Notice how the 10-year Treasury yield reacted following the previous rate increases, in Dec. 2015 and Dec. 2016. The 10-year rate yield actually went down

    (courtesy of StockCharts.com)

    If history repeats itself, this would be the third-straight time that long-term rates fall after the Fed announces a rate hike. Is this another coincidence or more of a trend?

    In Our Opinion...

    There are two misconceptions about how long-term interest rates behave in light of Federal Reserve policy.

    Misconception #1: Fed policy directly influences home mortgage rates.

    All rates are not created equal. The Federal Funds Rate best compares to a 1-month U.S. Treasury bill. A typical 30-year mortgage rate is going to channel the rate movement of a 10-year U.S. Treasury bond. Here is how closely the 10-year Treasury yield and 30-year mortgage rate move in tandem:

    (sources: Federal Reserve Bank of St. Louis, Freddie Mac)

    The correlation between the two is undeniable. If you look closely, notice that while the average 30-year fixed mortgage rate has risen a bit since the Fed began raising rates in Dec. 2015, the rise has been pretty tame. In fact, mortgage rates actually fell for the better part of six months after the Fed raised rates for the first time in 2015, as shown on the prior chart of the 10-year Treasury yield. How can this be?

    Misconception #2: Interest rates are set by the Federal Reserve and that's that.

    Interest rates, namely long-term ones, are driven by investor demand for bonds. They are not set by some monetary overlord. The Fed has a hand in guiding short-term rates, but investors collectively determine whether long-term rates go up or down, as bonds are traded within the market and subject to those forces of supply & demand.

    Here is how... Traditionally we think of buying a bond, earning its interest payment each year ("coupon rate") and receiving our full principal amount back at the end of the bond term (5 years, 10 years, etc). However, the bond market is more complicated than that. Bonds are traded every day in the market. As old bonds mature, new ones are offered through U.S. Treasury auctions, but not before being bought and sold along the way.

    Let's suppose you buy a bond and the next day investor demand is weaker for the same type of bond you purchased. Weaker demand means your bond is now worth less than what you paid. The interest you earn remains constant because the coupon rate is fixed at the time of purchase, but the yield fluctuates over time. In this case, your yield goes up because the value of your bond went down.

    (Fixed coupon interest payment) / (Lower bond value) = Higher interest rate yield

    The opposite is true as well. This is why bond values and their interest rate yields move in opposite directions. If demand increases for your type of bond in the future, the value of the bond you own rises. This means you now have a lower yield. It's this type of ongoing supply & demand that drives long-term interest rates. The Fed plays a role, but investors truly determine whether rates rise or fall.

    In Our Portfolios...

    Stocks: No major changes last week, although we did tweak some positions in certain accounts where funds were recently added.

    Bonds: We sold one of our high-yield bond funds (ANGL) within smaller accounts and accounts that previously held both high-yield positions we use (the other being HYG).

    Q&A / Financial Planning...

    Staying on theme, a couple people asked last week whether to lock in their mortgage rate before the Fed announcement. My feeling is always the same -- do not base the timing of your home purchase loan or refinance loan off of Fed policy or how you think rates will behave. Lock in the loan when you need it.

    In the case of a refinance, if you can save money and the math all ties out, just lock it in rather than getting greedy. Pigs get fat and hogs get slaughtered. I do think rates will slowly rise over time but they won't spike overnight or in the course of weeks. Again, investor supply & demand should keep them in check.

    What's New With Us?

    If you have trouble logging in to Morningstar, it is because the original login request timed-out (due to security reasons). No worries though, just let me know if you need your access reset. You will have 24 hours to login from the time you receive the password reset email from Morningstar. If you do not do so within 24 hours we will reset it again.

    Have a great week!

     

    Brian E Betz, CFP®
    Principal