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2nd Quarter 2018

July 16, 2018

Inside This Newsletter

    • FIRST HALF 2018
    • THE FORTHCOMING U.S. DEBT CRISIS
    • COMING SOON – PAYING THE PIPER
    • A DEEPER DIVE INTO EMPLOYMENT NUMBERS
    • WHO WANTS TO COOK?
    • CHARITABLE DEDUCTIONS ON YOUR TAX RETURN

Please join us in welcoming John-Paul Pavao. He recently came on board to work as an assistant to operations and financial planning.

FIRST HALF 2018

Global stocks declined nearly 0.5% in the first half of 2018. However, this small change masked the differences between international stocks declining 4% in the first six months of the year while U.S. stocks gained about 3%. In large part, the difference between international and U.S. stocks are mirror opposites of 2017 during which international stocks outpaced domestic stocks by 6%.

Bonds declined nearly 2% so far this year. This means that a portfolio balanced between bonds and global stocks is down slightly year to date, though this represents a very short period of time.

Please contact us if you would like to discuss your portfolio.

THE FORTHCOMING U.S. DEBT CRISIS

The new tax breaks for corporations and individuals is largely being subsidized by increasing the country’s debt – though not immediately.

The International Monetary Fund (IMF) expects the U.S. to have solid growth from the initial boost provided by the tax cuts. However, the large deficits requiring larger debt and servicing of the debt will be a drag on future growth.

The tax cut generated $1.5 Trillion. While those tax cuts work for a while, it is a bandage which will come off slowly. The IMF expects the growth to slow to 1.9% in 2020 from the 2.9% forecasted for 2018. So too are corporate earnings benefitting from a one-year significant tax cut.

The forecast of the debt needed to support the cuts is 4.5% of GDP by 2019, almost double the percentage from three years ago.

The IMF said current policies provide a near-term boost but increase future risk of the “already unsustainable” rise in government debt.

As usual, Washington seems to react short-term instead of looking for long-term solutions.

COMING SOON – PAYING THE PIPER

The Vanguard Group recently discussed their ten-year forecast for equity returns in the U.S. In nominal terms (includes inflation), they forecast an average annual return of 3-5%. Historically, the nominal average is 9-11%. Why?

You may have heard or read the phrase “borrowing returns from the future.” It relates to:

  • Central banks around the world artificially keeping interest rates low
  • Bought assets (Quantitative Easing)
  • 2018 fiscal stimulus late in a business cycle

This has resulted in:

  • Reduction of risk premium
  • Encourage companies and households to spend

While the stimulus may last this year and next, it does stop. In the meantime, the Fed is looking at four rate increases in 2018 and three in 2019.

With the “easy money” environment now over, we “have to give back,” according to Vanguard’s Peter Westaway. Hence the expected low returns from stocks over the next 10 years.

International equity return expectations are 5.5-7.5% (nominal).

A DEEPER DIVE INTO EMPLOYMENT NUMBERS

The May employment numbers stated there were 223,000 new (nonfarm) jobs created. Unemployment now sits at 3.8%. However, everyone is not benefiting from new job creation. Looking deeper into the numbers we find:

  • Unemployment rate of African Americans – 5.9%
  • Teenagers looking for work – 12.8%
  • Long-term unemployed (no job for 27 weeks or more) – 1.2 million
  • Employed part-time (translation – haven’t been able to find full time work) 4.9 million
  • Looked for work for the past 12 months but gave up in April – 1.5 million

We frequently hear that manufacturing is going offshore, yet the new job numbers don’t support that premise.

  • Transportation and warehousing – added 156,000 jobs over the past year
  • Manufacturing employment increased 259,000 over the past year
  • Jobs in information, financial activities, leisure, hospitality, and government are unchanged

Many employers will say they can’t find “qualified” people to fill their job openings. As we have written before, a major issue is re-training people to fill positions in areas requiring a new or different skill sets. From our perspective, the only way to solve this problem is through educational offerings by companies, in conjunction with educational institutions or by the government. Unfortunately, we don’t see much in the way of progress.

WHO WANTS TO COOK?

When Amazon purchased Whole Foods over a year ago, many expected disruptions in the grocery store business – the same as Amazon disrupted book selling, etc. While Amazon has begun to change the grocery store dynamic with its discounts for Prime members, selling of some products within Whole Foods and lockers for merchandise pick-up, it seems a major disruption for grocery stores is not being caused by Amazon.

According to Spencer Jakab’s Heard On The Street in the Wall Street Journal, June 20, 2018, a major change is the public’s attitude toward cooking. More people do not want to cook. According to 2016 U.S. data, almost 44% of food dollars is spent on food not prepared at home.

This isn’t a positive statistic for supermarkets. More money is going to eating in restaurants and meal-kit-delivery services. Among the top five identified in the Bay Area by Cappsool Technologies survey:

  • Sun Basket
  • Home Chef
  • Hello Fresh
  • Plated
  • Blue Apron

The supermarkets are fighting back by enlarging their prepared food offerings.

With so many of us conscious of time, busy schedules, balancing work/life, it appears taking time to cook is being replaced in part by pre-prepared or meal-kit-delivery options.

CHARITABLE DEDUCTIONS ON YOUR TAX RETURN

Much press has been devoted to the forecast that charities would see a significant decrease in contributions as a result of the new tax law. How? The standard deduction doubled so fewer people will itemize on their tax return.

The logic is since contributing to a charity could have been deducted under the old rules, a family won’t contribute under the new rules because it is no longer deductible with the increase in the standard deduction.

The forecast – approximately 30% of tax returns were itemized; under the new rules the expectation is 10%. No itemization, no charitable deduction.

Example:

Charitable contribution $14,000
State and local tax deduction cap $10,000
Total $24,000

Standard deduction is $24,000

Therefore, the charitable deduction doesn’t offer a benefit.

What I have not seen, is a discussion about donating because you believe in a cause. The press makes it sound like the only reason people contribute to charities is for tax purposes. While it is naïve to think it is not part of the decision, it isn’t the only reason – at least for clients of Financial Connections.

I don’t know that our clients are unique from other Americans. Our experience is that our clients contribute because of the passion for a cause or the support of a disaster; the tax deduction is a bonus. Bravo Financial Connections clients!!!!

 

Potential Workarounds

One strategy is to accumulate several years of donations in one tax year and put the money in a Donor Advised Fund (DAF). If enough, you should be able to itemize that tax year to take advantage of the contribution to the DAF. You can take your time to donate to the charities of your choice over several years.

Another option might be to donate appreciated stock/mutual funds to the DAF for a deduction.

If you would like more information, please contact us.

Resources

IN THE MEDIA

Financial Connections makes its staff available to journalists to share knowledge.

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