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®

    The Decline Of General Electric Teaches A Cautionary Lesson

    In The News...

    Thomas Edison's company did something for just the third time in its 125-year history.

    General Electric (GE), founded by Edison back in 1892, slashed its dividend payment in half from 96 cents to 48 cents per-share annually. According to CNBC it is the 8th-largest dividend cut in history (the 7 others greater than this occurred during the last recession). When were the other two times GE's longstanding, steady dividend was reduced?

    1938
    2009

    Notice something those two years have in common? The first was during the Great Depression and the other was during the 2008/09 financial recession. Interestingly, those previous dividend cuts occurred near the tail ends of stock market recessions. So this likely says more about the health of GE as a standalone company than it does about the broader economy, considering we are not currently in a recession.

    GE shares are down a staggering -42% from the highs back in 2016 and -24% in the past month alone. The value of GE stock has not been this low since 2012.

    The lesson learned from GE: I bring this up for a couple reasons. One, because of how rare it is to see a dividend cut of this size. Two, as a reminder of something I wrote about a few weeks ago where I highlighted four ways that investors are overly emotional about investing. One of the ways is that we become too infatuated with a particular company, often because it is where we work. As a result we make risky decisions such as owning too much of that one particular stock or loading up on that stock in a 401k account.

    If you worked for GE this type of downside risk is now a reality as the stock price has precipitously fallen some -40% in less than a year. I say this with great sympathy, in the event someone you know works there. But fairly or unfairly this is an example of what the other side looks like, not what we are more prone to hear about with companies like Google, Amazon or Boeing, where share prices have been on fire for the past decade.

    It is likely that GE stock will rebound at some point, but how soon will that be? Also, what constitutes the rebound? Will it ever get back above $30 per-share? Hard to say.

    A step toward tax reform: In other news, the Republican-led House of Representatives passed its tax reform bill on Thursday. This was expected. What is more unclear is whether there will be enough votes in the Senate to pass this bill, or some iteration of it, given that Republicans only out-seat Democrats by two members in the Senate. The biggest debate forthcoming is whether a repeal of the individual health care mandate will be included in the reform. The mandate was part of the Obamacare plan that took effect in 2010. Repealing it would reduce government spending but also mean millions of Americans would be without health insurance. (I covered some of the proposed tax changes here.)

    In The Market...

    The S&P 500 slipped -0.1% this past week. Let's look under the hood:

    (price data via stockcharts.com)

    Ironically, it was an eventful market week despite the S&P 500 going nowhere. It was a total mixed bag, without much reason. Some growth sectors rose, like Consumer Discretionary, while others fell, like Industrials and Technology. Meanwhile, the more defensive sectors (Utilities, Consumer Staples) gained, while the bond market rebounded in unison as well.

    The market rally has leveled off over the past month, as the S&P 500 index has stalled out just shy of 2,600. But because we have seen more volatility at the sector-level that has created some good buy/sell opportunities for us. This past week we were more active than usual in buying and selling investments (listed below), which is how we tend to be when the market is rising. For more on why this is, see the OPINION section below.

    In Our Opinion...

    I get asked how often we buy and sell investments within client accounts.

    Daily?
    Weekly?
    Monthly?

    The answer is it really depends. We tend to buy an investment and hold it for a number of weeks before selling -- usually between 3 and 8 weeks. Because client accounts own multiple investments our transactions are staggered, which may give the appearance that we are buying/selling more actively than is the case. Larger accounts will have more investments and more transactions than smaller ones. We try to limit transactions on smaller accounts (under $50,000), because each $7.00 buy-or-sell transaction cost is proportionately more impactful on small accounts than larger ones.

    When the market trend is rising we are usually more active and when it is volatile or falling we try to be more patient. In a rising market there tend to be ebbs and flows where certain sectors perform better than others, kind of like right now. This lends to being more active. If the market is choppy, patience and poise are key. There are plenty of instances where we will own an investment that has fallen in value, but rather than sell it we will re-evaulate and may hold it for a period of time in anticipation that it will rebound.

    What I am describing speaks to our investment process as much as anything. Our process isn't short-term and it isn't really long-term. It is somewhere in between. If we were to rapidly trade investments that would be inefficient to you. If we were to buy-and-hold for years our value would be pretty moot after the initial allocations are made because we would not actually manage anything over time.

    In Our Portfolios...

    Q&A/Financial Planning...

    I encountered a situation rolling over a client's Boeing 401k this week that might apply to you.

    When you leave a job or retire, we almost always recommend rolling over your 401k to an IRA. Most of the time 401k rollovers are straightforward. Your pre-tax funds are rolled over into a Traditional IRA. Your Roth 401k funds (if you have them) are rolled over into a Roth IRA.

    Simple enough, right? But what if you have "after-tax" funds in your 401k?

    Not to be confused with Roth 401k funds, after-tax 401k elections are the contributions you make when you want to contribute more than the $18,000 limit. A lot of company 401k plans allow this, often unbeknownst to the employees. After-tax contributions are similar to Roth 401k contributions in that the funds contributed have already been taxed. But there is one key difference... Your Roth 401k contributions grow tax-free, whereas after-tax 401k contributions grow tax-deferred. This means the after-tax bucket of your 401k contains BOTH pre-tax and post-tax dollars, despite the "after-tax" misnomer.

    How this affects your 401k rollover: Your 401k statement may not separate your pre-tax and post-tax dollars relating to your "after-tax" contributions. In fact, your 401k provider may include the entire after-tax bucket of funds in one rollover check, instead of separating that chunk into a tax-deferred rollover amount (the earnings that stem from after-tax contributions) and a tax-free amount (the contributions themselves).

    Why this poses a problem: If you do not separate the tax-deferred earnings portion from the tax-free contributions portion, you may accidentally rollover all of it as tax-deferred funds into your Traditional IRA. This means you would end up paying income taxes TWICE on those savings -- once when you originally contributed them into your 401k and again when you withdraw them in retirement!

    Why? Because unless you maintain records showing the after-tax money that was contributed years/decades ago, no one else will either. The IRA custodian will assume those withdrawals are all taxable down the road when you begin taking withdrawals. Even if you do have such records, such record-keeping will be frustrating to maintain in future years. Plus, you will constantly have to recalculate what percentage is taxable from what proportion is not (a whole other issue that I won't detail here).

    Our client's Boeing statement luckily provided enough detail for me to figure out how much of her total 401k is pre-tax vs. true after-tax, but other 401k plans may not be that helpful. 401k rollovers are pretty easy, but it is important to take inventory of your tax-deferred vs. tax-free money to ensure that the right amounts are rolled over to a Traditional IRA and Roth IRA, respectively.

    What's New With Us?

    I wrote a new article on our general blog page: How The RMD Laws Could Rock Your 401(k) Or IRA In Retirement. Much of this I discussed a few weeks back in our weekly blog, but I wanted to expand on the Required Minimum Distribution (RMD) rules and provide something informative for non-clients. Feel free to share.

    Have a great weekend!

    Betz Signature 250px.png
     

    Brian E Betz, CFP®
    Principal

    GOP Unveils Its Tax Plan. Could It Lead To A Housing Recession?

    In The News...

    Republican Congressional leaders released details of their tax plan. Here are the major reforms:

    • Income taxes: The number of tax brackets would fall from the current seven to four: 12% (assessed on taxable income between $24,000 and $90,000 for married couples), 25% (on income from $90,000 to $260,000), 35% (on income from $260,000 to $1 million) and 39.6% (income above $1 million). The most notable change is that the 25% bracket would cover income up to $260,000 for married couples. Today, income that exceeds $153,000 is taxed at 28% and income exceeding $233,000 is taxed at 33%. 
    • 401(k) contributions: No changes to contribution limits or deductions.
    • Small business taxes: A portion of pass-through income from business profits would be taxed at 25% rather than the owner's likely higher personal tax rate.
    • Mortgage interest deductions: Today you can deduct interest on up to two home mortgages, not exceeding $1 million in mortgage debt. The $1 million limit would be cut in half, meaning you could only deduct interest tied to a maximum of $500,000 in mortgage debt.
    • Standard tax deduction: This would double to $12,000 for individual tax filers and $24,000 for marries couples.
    • Personal exemptions: Would be eliminated. Today, you get to deduct $4,000 apiece for you, your spouse and any dependents in your household. So, a family of four would go from $16,000 in exemptions to $0.
    • Alternative Minimum Tax (AMT): Would be eliminated.

    There are more changes, but these are the major ones. For my personal thoughts on this initial GOP tax plan, scroll to the OPINION section below.

    New Fed Sheriff In Town: Four years after taking the reigns of the U.S. Federal Reserve, Chairwoman Janet Yellen is being replaced. President Trump's nominee, Jerome Powell, will take over the Fed in Feb. 2018 when Yellen's term expires. Yellen has held the position since 2014. She took over the post from former Chair Ben Bernanke (2006-2014), who in turn took it over from Alan Greenspan (1987-2006).

    What does this regime change mean to future monetary policy? Probably not much. From what I have read Powell was a supporter of Yellen and the two were largely in lockstep with regards to the timing of interest rate hikes. I highlight that because among those who have bashed the Fed, the biggest backlash has been how long it took the Fed to begin raising interest rates. While the change in leadership initially seems like no news, remember that this is Trump's appointee. Trump had promised major shake-ups to monetary policy and it appears that will not be the case. In my view that is wise. I am also not surprised at the pivot, either.

    Latest on real estate: Housing prices gained +0.5% in August, per the latest S&P/Case-Shiller report. The tide might be turning a bit, as Seattle homes appreciated just +0.2% for the month and Portland homes were up +0.1%. San Francisco was the only of the 20 major cities tracked that saw prices decline, slipping -0.1%.

    Annually speaking, homes have appreciated nationwide by an average of +6.1%. Seattle real estate has gained +13.2%, while Las Vegas ranks second with prices rising +8.6%. Here is a complete city-by-city look:

    I would expect housing prices broadly to settle in to the +4% to 5% annual growth range in the coming year. That is more representative of a smooth housing market. I would expect prices in/around Seattle to slow a bit as well, meaning prices that rise at a slower pace than the currently torrid +13% growth. Seattle homes should remain near the top compared to the other major cities, given the ongoing tech migration and recent success of Amazon, Boeing and Microsoft.

    In The Market...

    The S&P 500 gained +0.3% this past week. Let's look under the hood:

    (price data via stockcharts.com)

    Ten months down, two to go. So far 4th quarter seasonal strength I have preached has been as advertised. The S&P index rose +2.3% in October. Staring down the barrel of November and December, here is a recent historical look at how the S&P 500 has performed in these two months, cumulatively (including dividends):

    2016: +5.9%
    2015: -1.4%
    2014: +2.4%
    2013: +5.6%
    2012: +1.8%
    2011: +0.7%
    2010: +6.7%
    2009: +8.1%
    2008: -6.6%

    As you see, broad market performance has been positive nearly every year in these two months over the past decade. Coming off a somewhat mixed week, with four of the 10 sectors being in the red, I still believe market conditions look strong moving forward. Next week I will dig into earnings season results, which will begin to wind down.

    In Our Opinion...

    Among the proposed tax reforms, the most significant may be the slashed mortgage interest deduction. You can currently write-off interest tied to $1 million in mortgage debt. Under this tax proposal that $1 million limit falls to $500,000, meaning a reduced tax deduction if your mortgage exceeds $500,000. Here is what Jerry Howard, CEO of the National Association of Home Builders, had to say about it on CNBC:

    "There are seven million homes on the market right now that are more than $500,000. Those houses are automatically going to be devalued." -- Jerry Howard, National Association of Home Builders

    Howard went on to say that this would lead to a housing recession, as such depreciation would become contagious and spread across real estate markets. This is a bombshell quote considering the source.

    Rather than use $500,000, a more appropriate number to cite would be $625,000. At that purchase price, assuming the home buyer puts the standard 20% down toward the home, the resulting mortgage would be exactly $500,000. If your mortgage balance today is less than this, you are unaffected. If it is more, your tax deduction falls.

    But is it that straightforward? Maybe not. First, remember that deducting mortgage interest is part of itemizing your tax deductions, rather than taking the standard deduction. Under this tax plan the standard deduction would double from $6,000 to $12,000 for individuals and $12,000 to $24,000 for married couples. On its surface it appears this would compel more people to take the standard deduction and fewer people to itemize. Let's just see...

    Let's assume that your average mortgage balance during the year is $500,000 and the interest rate on that mortgage is 4.50%. That means you would have paid the following in mortgage interest throughout the year: $500,000 x 4.50% = $22,500 in mortgage interest paid.

    Is it a coincidence that this is very close to the $24,000 standard deduction for married couples? Probably not. So, in a vacuum, if the only itemized deduction you had was interest tied to a $500,000 mortgage, you would be very close to the break-even point between itemizing vs. taking the standard deduction.

    Back to Howard's quote... I disagree that this change would lead to a housing recession, for two reasons. First, if we are talking about residential homeowners, their list of reasons for buying a home likely does not include whether they can deduct all of the resulting mortgage interest. If their list of reasons does include such math, it is probably toward the bottom of their priorities. Existing homeowners will still upgrade into a bigger/nicer home if their life needs it and their finances allow it. First-time home buyers are new to the game and won't know any different.

    Second, real estate investors (the other type of buyer) are unique. I would suspect many of them purchase with cash, meaning little-or-no financing. I would further assume real estate investors are already deducting the interest tied to the mortgages on their primary residence, if they have a mortgage at all. If they purchase additional real estate with the help of a mortgage they cannot deduct that mortgage interest today anyway, so reducing the debt limit from $1 million to $500,000 is irrelevant to them.

    It is hard to give too much opinion on the overall tax plan because the details are fresh and there seems to be a number of potential tax offsets. I do favor a simpler tax code and like seeing fewer income tax brackets (I have actually long-favored a flat tax). I would be interested to know your thoughts -- feel free to email me with them.

    In Our Portfolios...

    Q&A/Financial Planning...

    Do you know your 401(k) vesting schedule?

    Mostly likely not. If you just started a new job or are unsure how long you will stay at your current one, make sure you know the vesting requirements on these employee benefits:

    1. Employer contributions made into your 401k account
    2. Restricted stock (RSUs)
    3. Stock options

    "Vesting" means how long you have to wait until you have earned the dollars or shares granted to you. When it comes to restricted stock or stock options awarded to you, the vesting is usually stated pretty clearly on a statement. When it comes to employer 401k contributions, namely the matching provisions, you usually have to dig into the 401k plan summary to know the vesting schedule.

    For example, I recently reviewed the new 401k plan for a client who changed jobs earlier this year. He earns a 25% employer match on up to 6% of his pay. So, if he contributes the full 6% that is eligible for the match, his employer effectively contributes 1.5% of his salary into his 401k. Those employer dollars vest in four increments: 25% after 1 year of service, 25% after 2 years, 25% after 3 years and the remaining 25% after 4 years.

    This is key because he is not sure if he will be with the company for four years (as most people aren't given how frequently workers change jobs these days). There is value in pointing out what money he would be at risk of losing should he leave at any time within the first four years of employment.

    It is common for the quality of the employer match to persuade or dissuade people from participating in the 401k at all. That is for another conversation, but the point here is that if you are spending time evaluating the employer match you better look at the vesting schedule while you are at it.

    What's New With Us?

    As I mentioned a few weeks ago, I am going to start creating some short, YouTube-like videos that address different aspects of our firm. The first one will be on our investment philosophy and how it compares to traditional long-term investment theory. I'll be eager to get some feedback.

    Last weekend it was 70 degrees here in Seattle. Today it is snowing. Go figure...

    Have a great weekend,

    Betz Signature 250px.png
     

    Brian E Betz, CFP®
    Principal

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

    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