FOURTH QUARTER ECONOMIC OUTLOOK

US & World Economy

by LESLIE CALHOUN President and CEO

One for the record books! We have now broken all bull market duration records and have reached all-time highs in our US stock market. Our economic expansion is slowing but some of the weaknesses in GDP can be blamed on unresolved trade wars and there is no telling when it ends. We have been making forward progress for years, seeing some slippage at times, but climbing nonetheless. After seeing rates rise for the first time in years last year (2018), housing construction and home purchases experienced contraction and manufacturing slowed. Worldwide growth slowed and then trade wars ignited and earlier this year putting the long economic expansion at a tipping point. The Fed was quick to respond first by halting rate hikes and then the yield curve inverted by the end of spring and recession fears returned. To mitigate the growing anxiety the Fed made a quick about-face and began lowering rates during the summer of 2019. Three consecutive rate cuts appear to have worked and trade negotiations have progressed with our largest trade partner, China.

European economic recovery is also making progress albeit weaker than the US. It appears Germany will avoid a prolonged recession and Brexit is likely “baked-in” to markets for the foreseeable future. China is showing the greatest contraction in its economy but they have been falling from recent years of 10% GDP down to about 6%.

The US has low and dropping bond yields but we are still positive and attracting investors at a rapid pace as 60% of sovereign debt worldwide has negative interest rates making the US bonds very attractive. And as bond yields drop, their prices rise. This is forcing investors to take on increasing risk. Negative and depressed interest rates are driving investors to equities for the wrong reasons. Cheap money has allowed companies to repurchase their stock with borrowed money to reduce dividend expense and this along with a pursuit for income from investors has driven our markets to new all-time highs. On October 15, in a research note published by Bank of America Securities, portfolio strategists argue that there are good reasons to reconsider the role of bonds in an investment portfolio because the relationship between bonds and equities has changed so much that investors now buy equities for current income and they buy bonds to participate in price rallies. Indeed, there are now 1,100 global stocks that are providing dividend yields above the average yield of global government bonds.

Financial Planning

by BART ZANDBERGEN, CFP^® Senior Wealth Advisor

As we close in on the last two months of 2019, many individuals are focused on learning more about what they can do to ensure they’re in the best taxation position possible for their given situation. This is a hot topic for many of my clients, and one we plan wisely throughout the year. However, it is not too late to make some strategic decisions that can yield favorable results come tax filing time in 2020.

Here are four options to consider that may be helpful to reduce your tax impact:

1. QUALIFIED OPPORTUNITY ZONE: This was a little-known tax benefit rolled out in the Tax Cuts and Jobs Act of 2017. A Qualified Opportunity Zone investor may defer eligible capital gains recognized from taxable exchanges such as the sale of stocks or bonds, the sale of a property, or the sale of an interest in a partnership. Both long-term and short-term Capital Gains can be invested in on Opportunity Zone fund. Each investor generally must invest Capital Gains into the Opportunity Zone Fund within 180 days of realizing Capital Gains. The investor may then defer the federal capital gains until 2026. If the investment is made in 2019, there may be a 15% discount applied to the federal capital gains tax in 2026.

2. DONOR ADVISED FUND (DAF): This is a simple charitable fund that the donor manages. The donor contributes cash to this fund and can take a 100% tax deduction up to the available limits. The funds in this account can be managed for growth. The Donor has the rest of his/her life to decide when and how much to give to a charity of their choice. This is a great planning tool for someone who had an unusually high-income year, be it salary, stock sale, or sale of a company or property. This has no setup fees or ongoing tax filing.

3. CHARITABLE REMAINDER TRUST (CRT): This trust is designed to ultimately be paid to a charity of your choice. Once funded, you can transfer either cash, highly appreciated assets like stock or real estate, and sell the asset within the trust with NO tax. You can then set up an income stream to be paid to you for the rest of your life or your spouse’s life. Any remaining funds will be paid to the charity of your choice. You would receive a tax deduction this year for the present value of the ultimate gift to the charity. This does require an attorney to draft the trust and does have ongoing tax filing. This is a great tax planning tool for someone who would like to sell an appreciated asset and pay no tax.

4. CHARITABLE LEAD TRUST (CLT): Very similar to the Charitable Remainder Trust (above). The difference is that instead of the donor receiving income for life, the Charity receives income for a pre-determined amount of years. At the end of the term, the remaining principal is returned to the donor. The tax deduction is based on the number of years of payment to the charity as well as the annual rate paid to the charity. A good planning tool is to choose one’s Donor Advised Fund as the charity to receive the annual payments. That gives ultimate flexibility to the donor as to whom, when, and how much to give.

There is no time like the present to plan for tomorrow, so contact your advisor today to learn which of the above options may be a good fit for you. After all, your future self will be glad you did!

Longest Running Bull Market – Does it Imply an Impending Deep Recession?

by MATT MCMANUS, M.A., CFP^® Senior Wealth Advisor and COO

As I sit here writing this piece, we are now experiencing the longest-running bull market in history and producing new highs on a number of indices. This is occurring among the backdrop of global political instability and a trade war that is affecting every sector of the United States economy. Thus the question gets asked, when does the recession hit and will it eclipse the Great Recession of 2008?

Many mainstream theories hold that recessions are the result of unpredictable events — changes in the rate of technological innovation, monetary policy or asset prices — that randomly speed the economy up or slow it down. Some alternative theories hold that booms cause busts because good times allow bad investments to build up in the financial system. According to these theories, the larger the boom, the larger the crash that follows.

Then there’s the so-called plucking model. Proposed by the economist Milton Friedman, it holds that the economy is like a string on a musical instrument — recessions are negative events that pull the string down, and after that, it bounces back. Just as a string snaps back faster if you pull it harder, this theory holds that the deeper the recession, the faster the recovery that follows. But you can only pluck the economy in one direction; bigger expansions don’t lead to bigger recessions.

Friedman’s plucking model assumes that output can only move along a ceiling corresponding more or less to the full utilization of capital and labor, or be plucked downwards. Plucking shocks are temporary demand shocks, whereas fluctuations of the ceiling itself are determined by supply shocks (technologic, demographic, regulatory, etc.). Bigger recessions should lead to faster and prolonged growth rates during the recoveries like we are experiencing now, to get the economy back to the pre-recession level of activity. In the plucking model world, the size of the recession predicts the growth rate in the recovery.

That leaves the question of why the economy would act like a string that can only be plucked in the downward direction. Macroeconomists Stéphane Dupraz, Emi Nakamura and Jón Steinsson layout a model suggesting it depends on the way companies set wages. Essentially, it’s easy to give people raises, but hard to make them accept pay cuts. In good times, growth simply feeds into higher wages (as well as higher profits). But when a recession or other negative shock comes along and dampens corporate earnings, employers that might like to cut wages can’t. Instead, they lay off workers. The more workers who get laid off create a bigger pool of unused labor and supply which in turn provides a surge of resources that enables the economy to grow faster once a recovery begins to take hold.

If Dupraz et al.’s model is right, the benefits to stabilizing the economy are big, because it’s possible to fight recessions with interest rate cuts and stimulus spending without making any sacrifices in good times. Instead of simply acting as a stabilizing force, the government can actually make unemployment permanently lower. (This is assuming, of course, that low rates don’t somehow lead to wasteful investment.)

When thinking about the incredible economic growth in the last decade, this plucking theory would seem to apply as the strong recovery that we have been experiencing is directly proportional to the size of our GDP-losses during the Great Depression. Further, this does not imply that we are guaranteed to face a deep recession similar to 2008 because of our record bull market in the last decade. The plucking model implies that recessions aren’t just the mirror image of expansions. They’re special events that disturb an otherwise placid process of economic growth. This has big implications for policy. Standard theories hold that while the economy can be stabilized by monetary or fiscal measures, the best that can be done is to iron out the fluctuations. But if the plucking model is right, then fighting recessions can actually raise the rate of growth overall. Just stimulate the economy whenever it gets plucked, and it’ll go happily on its way.

Portfolio Management

by STELLA CHOI, CFA^®, CFP^® Director of Portfolio Management

The performance for Global Equities was challenging for the third quarter. For the US, the market favored multi-factored investment style, and at the same time penalized small-cap stocks. There is a slight shift from favoring growth to more value style stocks. All of the international stocks were negative. Given being in the late cycle of the bull market, and steady run-ups of US equities, international equities are fundamentally cheaper relative to US equity prices. Going forward, having global exposures to equities will balance the over-priced US equities.

Global Real asset class had superb third-quarter returns. Looking through a spectrum of different time-periods in the chart below, it was one asset class that consistently did well. A security position in the self-storage space had a startling return of 16.45% for the quarter. Although, the repeat of the high degree of the return will be unlikely in the future. Even on a one-year return basis, Global Real Assets provided a steady return. Private Real Asset’s returns are not listed in the chart below. This asset class has a relatively low correlation to global equity and global fixed income. It will be a strategic asset class to hold within portfolios when the Global Equities and Global Fixed income become out of favor by the market.

For Global Fixed Income and Alternative asset classes look similar from the return standpoint. There was an interest rate cut of .25% during the third quarter which boosted the fixed income return. Most of the securities in the asset classes were positive which provide diversification benefit when holding the asset classes with the Global Equities.