THIRD QUARTER ECONOMIC OUTLOOK

U.S. & World Economy

by LESLIE CALHOUN President and CEO

This has continued to be another strong market quarter, with the U.S. economy entering the 11^th year of expansion, breaking previous expansion records. While the recovery that began in June 2009 has lasted 121 months, one month longer than previous record from 1991 – 2001. It is also the slowest recovery in modern times. This is not surprising considering how significant the 2009 trough was and how linked all economies of the world have become. Investment gains thus far in 2019 are derived from a solid rebound in global equities and fixed income markets as a result of both fiscal stimulus from the Tax Cuts and Jobs Act of 2017 along with more supportive monetary policy in the U.S. and abroad. While an inverted yield curve has been a harbinger of recessions in the past, it is a “leading” indicator and can occur months or years ahead of recession.

The U.S. GDP for Q1 2019 was better than expected at 3.1% but it has averaged only 2.3% since the Great Recession ended and looks to remain in this range with the caveat that there needs to be a resolution to the trade war for this to be sustainable. Inflation is solidly lower than it was in the mid-2000’s and hasn’t bumped over 3% since 2011 benefiting workers who should finally begin to see wage increases in the tight labor market.

Globally we expect Emerging Markets to continue to lead developed markets in economic growth due to so many issues plaguing developed markets like Brexit, Germany staving off recession, French social unrest, ballooning Italian budget deficits, etc.

While the Fed has stated downside risks to the U.S. economy have increased recently, our U.S. economy is holding up and much of this resilience results from the Fed’s commitment to be accommodative on rates. This stance has benefited fixed income investors with rising bond prices (lowering yields) and has consequently driven demand for equities. Worldwide, $13 trillion or 40% of the global debt delivers a negative yield and is driving bond investors to U.S. debt as a safe haven and for income. There has also been a move from negative yielding bonds into hard assets to preserve capital when their own safe haven assets provide negative yields but overall, bonds are currently overpriced relative to stocks (see below).

Financial Planning

by BART ZANDBERGEN, CFP^® Senior Wealth Advisor

Inflation 

Inflation rates have been at an all-time low. In retrospect, this could be a good thing. However, on the other hand, it can also be worrisome. We have to take precaution looking towards the future and make sure that assets are properly allocated in unison with changing trends. At the moment we see that there is ongoing growth while, at the same time, there is also a decelerating inflation rate. If we consider all this information, we could say that this would be the best climate for equities. But we also must forecast the Federal Reserve and see what their alternate reaction would be.

If interest rates are increased, we will most likely see a reduction in loans, which will in turn result in loss in disposable income. When disposable income is low, the economy slows down and inflation decreases.[1] According to market analysts, the upcoming forecasts predict that interest rates will go down over the next three to six months. This can lead to various different paths.[2] One can be an economic recession and another can be a cut in interest rates from a decelerating economy. Time will tell.

Typically, if the Federal Reserve does not implement an expansionary economic policy then both the interest and the inflation rates will be low[3] which could create a proficient environment for investing. This is a great time to have a well-diversified portfolio. Long-term financial success depends on out pacing inflation over the long haul and a diversified portfolio that includes stocks, bonds, real estate and alternatives offers the best chance of accomplishing that.

As always, we are here to answer any questions that you may have.

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[1] Pimco. “Understanding Inflation.” Pacific Investment Management Company LLC, PIMCO, 16 July 2019, global.pimco.com/en-gbl/resources/education/understanding-inflation.

[2] “Eaton Vance | Monthly Market Monitor.” Monthly Market Monitor | Eaton Vance, funds.eatonvance.com/monthly-market-monitor.php.

[3] Pimco. “Understanding Inflation.” Pacific Investment Management Company LLC, PIMCO, 16 July 2019, global.pimco.com/en-gbl/resources/education/understanding-inflation.

Tax Law Changes & Charitable Giving Strategies

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

As we pass the 2018 tax filing season, the first since the 2017 Tax Cuts and Jobs Act came into effect, many people were left with an unexpected tax bill. At first glance, the Act did not restrict the rules for charitable contribution deductions. But the interplay of the charitable contribution rules with the Act’s higher standard deduction and limitations on other itemized deductions provides both opportunities and pitfalls when making charitable contributions.

The Act roughly doubled the standard deduction to $24,000 for joint filers and to $12,000 for single filers. The tax writers estimate that this increase in the standard deduction will reduce the number of people who itemize from roughly one-third to fewer than 10%. However, charitable contributions are deductible only if an individual itemizes deductions. If the prediction is correct, fewer will itemize, and thus more will lose the tax benefit of contributing to charity.

An alternative strategy to now consider is “bundling” a number of years’ of charitable contributions into a single year. Bundling can allow people in that year to exceed the standard deduction, itemize their deductions, and receive a tax benefit for the bundled contributions.

Suppose an individual has $23,000 of itemized deductions, which includes a $1,000 donation to charity. The individual in this case will claim the standard deduction of $24,000. Because the individual does not itemize, the charitable contribution produces no tax benefit. Suppose instead the individual “bundles” an additional five years’ contributions in that year. The itemized deductions now total $28,000, greater than the $24,000 standard deduction. The individual will itemize deductions, saving up to $1,480 in taxes ((28,000 – 24,000) x 37%). The individual would then claim the standard deduction (and make no charitable contributions) for the next five years.

Those considering “bundling” might not want to give the five years’ additional contributions to charities all at once. Rather, they may prefer to continue their practice of choosing a charity each year to receive a $1,000 donation. To meet this concern, the individual could participate in or establish a “donor advised fund” (DAF). Contributions to a DAF are tax-deductible when made. However, the DAF is not required to distribute the proceeds to charities immediately. Instead, the DAF may dole out the funds in succeeding years to such charities in such amounts as the individual instructs at that time. (Of course, the individual does not receive a second deduction when the DAF distributes the funds.) To obtain an additional tax benefit, the individual could contribute appreciated assets (such as stocks, bonds, etc…) to the DAF and avoid the recognition of any unrealized long-term capital gains.

Of course, people contribute to charities for many more noble reasons other than tax savings. But in order to receive the tax benefits of those charitable contributions, it may be worth considering “bundling” a number of years’ of charitable contributions in 2019. Consult with your tax and financial professionals before making any final commitments to understand the effects on your unique situation.

Portfolio Management

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

As the stock market bull trend has now extended more than 11 years, Wall Street is wondering when this steady upward trend will turn its course. However, as I am writing this commentary, the Dow Jones index has broken 27,000 and is still going. In fact, there doesn’t seem to be signs of a slowdown of the global equity markets either. In reviewing the most recent quarter, Global Equities’ second quarter returns ranged between 4.3% to lowest 1.93%.  In addition, Large Cap equities ended up doing better than Small Caps and Growth companies exceeded the performance of Value companies. Additional change to note was the trend of emerging market equities doing better than other regions’ returns due to the weakening dollar.

In Global U.S. Real Assets, Gold was the best returning sub-asset class, which makes sense since the Dollar was weaker during the quarter. Commodities were the only negative returning sub-asset due to the slowdown of global growth and the on-going trade war between U.S. and China.  However, in anticipation of this occurring Optivest made a tactical change ahead of time in the Real Asset class by consolidating the different sub-asset classes that would usually be divided between things like commodities, agriculture, and energy to one fund that can enact tactical allocations based on an institutional quantitative process. This new fund contains global infrastructure, commodities, natural resource equities, global real estate, and inflation hedged Treasuries; thereby allowing us to have the flexibility to move into the segments of the real asset market that makes the most sense from a macroeconomic standpoint.

In terms of Global Fixed Income, higher credit quality did better than lower credit which is a change from the previous quarter. High quality corporate debt returned 5.41% versus lower quality corporate debt returning 1.48%. Also the weaker U.S. dollar helped emerging debt to return 5.47% for the second quarter. During the second quarter, Optivest also made a model change of moving from a passive strategy to an active strategy in the asset class.  With the low yield and the extended positive return environment for Global Fixed Income, we selected two active bond managers to navigate this environment to lower risk and optimize return. In our view, this asset class will be a challenging landscape to repeat the past returns with the risk building steadily due to continued cheap borrowing costs for lower credit rated companies and countries.

In the Alternative space, most of the strategies resulted in bond like returns and we made no structural changes for the quarter. We are continuing to monitor the life settlement fund as it recently has been experiencing lower returns. However, it is completely uncorrelated to the market which continues to help us reduce risk over the long run.  We are continuing to research additional Alternative options that can help mitigate risk without giving up too much return.