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:
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:
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...
'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,
Brian E Betz, CFP