3/17/17 – Fed Raises Interest Rates, Stocks Up Slightly

Stocks Increase Slightly, Fed Raises Interest Rates

  • Stocks rebound to a small gain this week
  • As expected, the Fed increased the fed funds rate 0.25%
  • North Korea in the news

After suffering their worst week of the year last week, both indices rebounded and increased slightly this week. The Dow gained 0.1% while the S&P 500 increased 0.2%.

The Federal Open Market Committee met this week and agreed to raise interest rates 0.25%. This was widely expected, but stocks managed to rally immediately following the announcement. The rally was broad-based with even utilities increasing. Utility stocks, given their high dividend yields, often sell-off when interest rates rise as the relative attraction of the dividend decreases. This suggests to me the market fully expected an increase and took the increase as a signal of a strengthening economy. Additionally, the comments from Janet Yellen suggested that two additional increases were likely this year. Some had speculated three more could happen this year and I think that reassured dividend investors that rates wouldn’t more too much higher in the near term. Read More

The US announced what appears to be a fairly significant change in policy to dealing with North Korea, although the news didn’t seem to impact markets today. North Korea has nuclear weapons, but doesn’t yet have the missile capability to reach the west coast of the United States. They have expressed a desire to do that and they repeatedly test missile launches in the Pacific Ocean. Last week, North Korea launched four ballistic missiles towards Japan, saying it was a test for attacking US forces in Japan. Secretary of State Rex Tillerson said this week that all options would be on the table if North Korea increases its threat, including a preemptive military strike. I don’t know what the long-range plan/solution is to North Korea, but I always assume these dictators want to talk tough, but also want to remain in power, which hopefully keeps the status quo going forward. There’s been very little geopolitical news impacting markets lately, but this is a situation to monitor. Read More

Oil bounced back this week, increasing 0.7% to close at $48.79/barrel. The yield on the 10-yr Treasury decreased, closing at 2.50%, from 2.58% a week ago. The average rate on a 30-yr mortgage extended a 2017 high, moving to 4.30% from 4.21% last week.

Close Weekly YTD
Dow Jones 20,914.62 0.1% 5.8%
S&P 500 2,378.25 0.2% 6.2%
Oil 48.79 0.7% (9.5%)
10-yr Treasury (∆ in bps) 2.50 (7) 5

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3/10/17 – Stocks Down, Jobs, Fed & Debt Ceiling in the News

Stocks Break Winning Streak, Jobs, Fed & Debt Ceiling in the News

  • Stocks suffer their worst week of 2017
  • February jobs reports stronger than expected
  • The Fed meets next week, interest rate increase likely
  • Debt ceiling back in the news

Both indices endured their worst week of 2017. The Dow broke a 5-week winning streak, while the S&P 500 was down for the first time in seven weeks. On the week, the Dow and S&P 500 declined 0.5% and 0.4%, respectively.

The Bureau of Labor Statistics released a very strong February jobs report this morning. The economy added 235k net new jobs last month, well above the consensus estimate of 190k. This follows a strong ADP jobs report on Wednesday and suggests businesses are optimistic about the direction of the economy. Over 160 million Americans are working, the most in history. The unemployment rate declined to 4.7%. As I’ve mentioned many times over the last few years though, the unemployment overstates the strength of the labor market in my opinion. People who haven’t actively looked for a job in the prior four weeks are not included in the labor force. This excludes millions of Americans who are long-term unemployed and have given up looking for work. There are still over 94 million working age American not working. I think what we’re seeing is a nice sign of optimism from corporate America, but also a continuation of many of the same trends we’ve seen for years. Jobs are growing at a nice rate, but many people are still on the sidelines in need of a stronger labor market. Read More

The Federal Reserve Open Market Committee meets next week and it is widely expected they will decide to increase the Fed Funds rate by 0.25%, or 25 basis points. The strong jobs report today essentially finalized the decision and the market seems to be happy with it. In the 2012-2015 period, every time investors thought the Fed would raise rates, stocks would sell-off and vice versa. Today, most investors seem ready to welcome higher rates. I think this is because people recognize the economy is in a much better position today that it was a few years ago. My expectation for the year is we’ll see three, and potentially four rate increases. This could be a nice boost to savers as interest rates on savings accounts and fixed income investments increase. It could cause some volatility and unpredictability in the bond market in the short-term, but overall I believe this is a positive for investors. I know I would like to see higher returns in the fixed income portion of portfolios.

Eighteen months ago, Congress voted to suspend the debt ceiling. This happened a few times during the Obama years, where the ceiling was suspended instead of being raised. It’s sort of a semantic issue, since both options allow the government to continue borrowing money. The current suspension expires on March 16th so something needs to happen soon. I’ve argued over the years that the debt ceiling is pointless because we’ve raised it ~80 times over the years. Politically, it will entertaining to watch the situation evolve with one-party in control of Congress and the White House. Practically, we have to either suspend the debt ceiling again or raise it to some amount that will get us through another couple years. In spite of all the talk about fiscal discipline, the US has shown very little over the years, regardless of which party was in control. Read More

Oil was down sharply this week, decreasing 9.0% to close at $48.43/barrel. This is the first time since November that oil has finished a week below $50/barrel. The yield on the 10-yr Treasury increased, closing at 2.58%, from 2.49% a week ago. The average rate on a 30-yr mortgage reached a 2017 high of 4.21% from 4.10% last week.

Close Weekly YTD
Dow Jones 20,902.98 (0.5%) 5.8%
S&P 500 2,372.60 (0.4%) 6.0%
Oil 48.43 (9.0%) (10.1%)
10-yr Treasury (∆ in bps) 2.58 9 13

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Market Recap – March 3, 2017

Stocks Keep Moving Higher, the Difference Between Debt and Deficits

  • Stocks rally following Trump’s Congressional address Tuesday night
  • The words budget, debt and deficit were hardly mentioned in the speech
  • Snapchat IPO off to a good start

Stocks rallied sharply on Wednesday following President Trump’s speech Tuesday night. Wednesday made up over 100% of this week’s gains as investors responded positively to continued plans to cut corporate taxes and reduce business regulations. For the week, the Dow increased 0.9% while the S&P 500 increased 0.6%.

While taxes and regulations were focal points during the speech, there was very little mention of the budget, debt and our deficit in spite of a lot of spending discussion. The national debt is the country’s total amount of debt outstanding. Our debt currently stands around $20 trillion. Roughly 3/4th of the total debt is held by public investors and the rest is debt owed to other parts of the government. This intra-government debt includes the Social Security trust fund. There is no cash in the trust fund, rather the general budget has promised to payback the trust fund in the future. The US Gross Domestic Product is ~$18.5 trillion, so we currently have slightly more than a years’ worth of economic output in debt outstanding. For comparison, in 2007, US debt to GDP was 65%. Germany is currently around 75% while Japan is close to 230%.

The deficit is the annual shortfall between what the government spends and what it collects in taxes. The deficit for fiscal 2017 is projected to be ~$550 billion. This means that the government will need to borrow an additional $550 billion, increasing our total debt outstanding, to fund the shortfall this year. While we had a couple balanced budgets in the last years of the Clinton administration, total debt outstanding has increased every year since 1957. That means even in those years with a balanced budget on paper, the government still needed to borrow small amounts to fund the spending. No one really knows how long we can keep borrowing hundreds of billions of dollars a year to cover government spending. We’ve never had a problem borrowing money, interest rates are at historical lows, but it would have been nice to hear a plan or commitment to fiscal responsibility on Tuesday night.

Snapchat issued shares to the public (IPO) for the first time this week. Snapchat is the latest social media company to go public and is a very popular video/picture app with people under 25 years old. The company currently has a market valuation of ~$35 billion. To put that in context, that is the same size as well-known companies such as Deere, Adidas, General Mills and Southwest Airlines. While the market is valuing these companies similarly, Snapchat generated only $500 million in sales last year and lost over $500 million. It’s crazy that a company with $500 million in sales could be worth $35 billion. Southwest had sales over $20 billion and net profits over $2 billion last year. There was one unlikely winner in the IPO. A private high school in California invested $15k a few years ago into Snapchat. That stake is now worth $24 million. Not a bad investment for a group of high school students. Read More

Oil was down this week, decreasing 1.5% to close at $53.21/barrel. The yield on the 10-yr Treasury increased sharply, closing at 2.49%, from 2.32% a week ago. The average rate on a 30-yr mortgage moved lower to 4.10% from 4.16% last week.

Close Weekly YTD
Dow Jones 21,005.71 0.9% 6.3%
S&P 500 2,383.12 0.7% 6.4%
Oil 53.21 (1.5%) (1.3%)
10-yr Treasury (∆ in bps) 2.49 17 4

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Market Recap – February 24, 2017

Stocks up, taxes in the news, French elections upcoming

  • Stocks higher in last full week of February
  • Trump’s economic growth plan in the news
  • Important French election approaching

Stocks continued moving higher this week, the 5th consecutive week the S&P 500 increased and the 4th in the last five for the Dow. For the week, the Dow increased 1.0% while the S&P 500 increased 0.7%.

Incoming Treasury Secretary Steven Mnuchin talked about the administration’s economic growth plan in an interview with CNBC earlier this week. While specifics weren’t released, the framework included significant tax cuts for individuals and businesses and a reduction in business regulations. Mnuchin said the tax cuts were targeted for middle class earners and that any reduction in marginal rates for higher income people would be neutralized with declining deductions. I think lower rates with fewer deductions is a more efficient way to raise revenue. I also think it reduces economic distortions as people focus on business and investing instead of maximizing tax deductions. There was less information on corporate taxes in the interview, although the Border Adjustment Tax is still being discussed. The discussion lacked specifics on regulations as well, but he said the goal was reduce the regulatory burden on small and medium-sized businesses. Regulations often hit those firms the hardest because they lack the money or scale to effectively comply with myriad regulations. Mnuchin said they plann to have specific proposals and details released over the summer. As with all legislation, the details will be critical. Read More

French Presidential elections will become a bigger news/market topic over the next two months. The key reason markets are watching is what is means for the future of the EU and Euro currency. Marine Le Pen is leading in many polls and she has suggested France should abandon the common currency. Even though she appears to be leading in some polls, it would still take a pretty big upset for her to actually win the Presidency. French elections are structured very differently from ours. It’s a two stage process where the first round contains every candidate running and the top two vote recipients advance to the final round two weeks later. A candidate can win outright in the first election by receiving over 50% of the vote, but that has never happened and doesn’t appear likely to happen this year. While Le Pen polls well as peoples’ first choice candidate, she doesn’t appear as many peoples’ second choice. This suggest she is likely to advance to the final election, but most likely lose to the other runner-up as that candidate consolidates more of the votes from the eliminated candidates. That said, people are watching closely after the upset votes for Brexit and Trump as populist philosophy continues to take a greater hold in the West. Read More

I’m still thinking through what a potential Frexit would mean. This would be very different from Britain leaving because Britain has its own currency. Britain leaving the EU would/will cause some renegotiation of trade deals and work/travels rules, etc, but the country’s debt remains in the same currency and its central bank remains intact. Debt throughout the economy also remains in the same currency. If France leaves and returns to the Franc, billions in government and private debt could be at risk. It’s unclear how France would attempt to handle Euro-denominated debt in a transition and whether it would lead to a default. The biggest issue could be France losing access to funding from the European Central Bank and having to re-establish its own central bank. There’s numerous variables at play and if Le Pen’s popularity keeps rising, expect to read/hear a lot more about the potential ramifications.

Oil was up this week, increasing 1.2% to close at $54.02/barrel. The yield on the 10-yr Treasury decreased sharply, closing at 2.32%, from 2.42% a week ago. The average rate on a 30-yr mortgage ticked slightly higher to 4.16% from 4.15% last week.

Close Weekly YTD
Dow Jones 20,821.76 1.0% 5.4%
S&P 500 2,367.34 0.7% 5.7%
Oil 54.02 1.2% 0.2%
10-yr Treasury (∆ in bps) 2.32 (11) (13)

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Market Recap – February 17, 2017

Stocks Up Again This Week

  • Stocks higher and Dow extends impressive streak
  • Mega mergers back in the news
  • It’s official! The Snuggie is a blanket

Stocks continued moving higher this week, the 4th consecutive week the S&P 500 increased and the 3rd in the last four for the Dow. For the week, the Dow increased 1.7% while the S&P 500 increased 1.5%. Both indices closed at record highs again. Markets are closed Monday in observance of President’s Day.

Today marked the 89th consecutive day that the stock market hasn’t had a decline of greater than 1%. A streak this long has only happened 17 times in the last 70 years. The streak dates back to October 11th, a month before the election. I always recommend people focus on the longer-term instead of worrying about the ups/down on individual days, weeks and months. However, it’s pretty interesting to look at the daily trading over that period. It’s been a generally upward moving market, but there have been very few days that were up over 1%, only four. Most days have been up/down less than 0.5%. There’s been a lot of hyperbole and chaos politically over the last three months, so it’s interesting that the market has been behaving exactly the opposite. Steady strength rather than sharp swings up and down. I think that bodes well for the market over the coming months.

Merger news dominated headlines today with the proposed $143 billion acquisition of Unilever by Kraft-Heinz. The shares of both companies increased, as did others in the sector such as Colgate. Unilever rejected the initial offer, but stock reaction suggests a higher offer might be forthcoming. It’s always interesting to see merger activity increase when stocks rise. On some levels, you would think lower share prices would encourage buyers to make acquisitions, but it always seem that exuberance from higher stock prices gets both buyers and sellers willing to do deals. Regardless of the stock moves today, this deal seems unlikely to happen to me. Britain is navigating whether it will leave the EU or not and this type of transaction is largely driven by potential cost synergies. Cost synergies is a fancy way of saying ‘layoffs’ so it seems unlikely that the UK would approve a merger where it would see significant jobs cuts while it faces uncertainty from a potential Brexit. Read More

Many of you likely remember the Snuggie from the late night TV commercials of the blanket with sleeves. I didn’t even realize Snuggies were still a thing, but apparently they’ve been in a long legal battle about whether Snuggies are blankets or robes. You might be wondering, ‘who cares?’ It’s an important distinction because of how blankets are taxed relative to clothing. If the Snuggie had been ruled as a robe, the import tax would have been 14.9%. As a blanket, however, the Snuggie only faces an 8.5% tax. Who would have thought the difference between a blanket and a robe would add up to real money. Read More

Oil was down this week, declining 0.8% to close at $53.37/barrel. The yield on the 10-yr Treasury increased slightly, closing at 2.42%, from 2.41% a week ago. The average rate on a 30-yr mortgage ticked slightly lower to 4.15% from 4.17% last week. Average mortgage rates are now down 0.17% from the beginning of the year.

My 2017 Form ADV is now filed and available for review. The ADV is a regulatory document filed every year with state financial regulators describing me and my business model. You can find the latest version here.

Close Weekly YTD
Dow Jones 20,624.05 1.7% 4.4%
S&P 500 2,351.16 1.5% 5.0%
Oil 53.37 (0.8%) (1.0%)
10-yr Treasury (∆ in bps) 2.42 1 (3)

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Market Recap – February 10, 2017

Stocks Rally in First Full Week of February

  • Indices close at record highs
  • Trump administration says corporate tax reform plan coming in 2-3 weeks
  • Key Fed Governor resigns unexpectedly

A strong Thursday and Friday pushed stocks higher on the week. The Dow increased 1.0% while the S&P 500 added 0.8%. The Dow, S&P 500 and NASDAQ all finished the week at record highs.

A lot of the strength the last two days was driven by an upcoming announcement on corporate taxes. In a meeting with airlines executives yesterday, Trump said that a ‘phenomenal’ announcement was coming in the next 2-3 weeks on corporate tax reform. There’s really been no info on what this potential proposal will include. House Republicans continue to discuss the Border Adjustability Tax, but it’s unclear if the administration will go in this direction. Stocks rallying on potential news has been a common theme in the last few months. We still haven’t seen many, if any, concrete proposals on financial regulation, corporate regulation, corporate taxes, etc and yet stocks are pricing in a lot of good news. Maybe the reality will live up to expectations. There’s an old saying on Wall Street, ‘buy the rumor, sell the news’ and that might be shaping up as true as we sit at all-time highs. I don’t make investment decisions based on potential short-term movements, instead preferring to buy quality companies that are attractive longer-term holdings, but we could see some market volatility as actual proposals come out and differ from the optimism people are currently projecting. Read More

Daniel Tarullo, a Fed Governor, unexpectedly announced his resignation effective April 15th. Mr. Tarullo was appointed by President Obama in 2009 and his term was scheduled to run until 2022. He didn’t give a reason for his departure, but it does leave three vacancies for President Trump to fill on the important seven-member committee. Fed Chairman Janet Yellen’s current term ends next February and it’s unclear whether or not she is interested in returning or whether Trump will ask her to return. The Fed Governors play an important role in financial regulation and this opening gives the Trump administration the potential to make significant changes. Read More

Oil was essentially flat this week, closing down one penny to $53.82/barrel. The yield on the 10-yr Treasury declined, closing at 2.41%, from 2.48% a week ago. The average rate on a 30-yr mortgage ticked slightly lower to 4.17% from 4.19% last week.

Close Weekly YTD
Dow Jones 20,269.37 1.9% 2.6%
S&P 500 2,316.10 0.8% 3.5%
Oil 53.82 (0.0%) (0.1%)
10-yr Treasury (∆ in bps) 2.41 (7) (4)

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Market Recap – February 3, 2017

Strong Jobs Report Fuels Friday Rally

  • Jobs reports leads to the Dow’s best performing day of the year
  • Headline jobs report strong, but wage growth disappoints
  • New admin delays changes to fiduciary rules

Both indices were helped by strong Friday rally, with the Dow gaining almost 1% today, its best day of 2017. On the week, the Dow lost 0.1% while the S&P 500 increased 0.1%.

The January jobs report came in well above expectations. The economy added 227k net new jobs in January, well ahead of the 175k consensus estimate. Construction hiring was noticeably strong as well, which is generally a positive for the overall economy. However, the Northeast had a very warm January, so it’s likely weather patterns allowed for more construction work than a typical January. It wasn’t all good news though. Wage growth was a paltry 0.1% on a month-over-month basis. Last month’s wage growth figures were revised down as well. Wage growth was still a reasonably healthy 2.5% over the last year. We’ve seen steadily improving wage growth over the last six months, so hopefully this month’s data is just a blip. The unemployment rate moved higher to 4.8% as more people returned to the labor force. Read More

I have always had a fiduciary responsibility to clients and will continue to going forward. That means, as a Registered Investment Advisor (RIA), I am legally required to put your interests ahead of my own. This is important for many reasons, but one of the most important is the use of high-fee products like front-end load mutual funds, unit trusts, annuities, etc. All of those products pay very generous commissions to advisors that would be hard to argue were in your best interest. Most advisors (Fidelity, Schwab, Edward Jones, Bank of America, etc) have never been held to a fiduciary standard, instead they are only required to put client assets into ‘suitable’ investments. Suitable is a very vague term open to significant interpretation, including many high-fee investments. Over the past year, the Obama administration put together new rules requiring all retirement accounts to be managed with a fiduciary obligation. This new rule was supposed to take effect in April, but the new administration is delaying/cancelling the new rule. There are legitimate reasons why a broker-dealer firm would struggle to provide a fiduciary responsibility, but clients would definitely benefit. Strangely, this is a good thing for me because having a fiduciary responsibility to clients is a good selling point relative to other advisors, but it’s not good for most customers. RIAs only make up 5-8% of total advisors, so most Americans do not benefit from the protections of an advisor who’s a fiduciary. Read More

Oil increased this week, closing up 1.2% to $53.83/barrel. The yield on the 10-yr Treasury remained flat, closing at 2.48%, the same as a week ago. The average rate on a 30-yr mortgage also held steady at 4.19%.

Close Weekly YTD
Dow Jones 20,071.46 (0.1%) 1.6%
S&P 500 2,297.42 0.1% 2.6%
Oil 53.83 1.2% (0.1%)
10-yr Treasury (∆ in bps) 2.48 0 3

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Market Recap – January 27, 2017

Dow Breaks 20,000 for First Time

  • Stocks up on the week, Dow reaches milestone
  • 4th quarter economic growth underwhelming
  • Busy week of earnings reports sees mixed results

Stocks rebounded this week and earnings season got into full swing. The Dow increased 1.3% while the S&P 500 added 1.0%. The Dow surpassed 20,000 for the first time on Wednesday and stayed above 20k through the rest of the week. While reaching this milestone is purely symbolic, it does provide some optimism and confidence. The Dow reached 10,000 for the first time in the fall of 2009. Interestingly, the top performing Dow stock over the period between Dow 10k and Dow 20k was the health insurance giant UnitedHealth.

The latest US economic growth estimate was released this morning showing the 4th quarter of 2016 grew at an annualized rate of 1.9%. This was below the consensus estimate of 2.2%. For the full year, economic growth was a pedestrian 1.6%. The 1.6% annual growth rate was the lowest since 2011. Declining exports were a large portion of the slowdown with export activity dropping at a 4.3% annualized rate. There were some positive signs though. Business investment increased at a healthy 3.1% annualized rate and consumer spending remained strong. From the end of World War II through 2008, the US economy grew at a annualized rate of 3.1%, but since 2009 growth has only averaged 1.8%. Read More

This was a busy week for earnings, with names such as IBM, Google and Microsoft delivering better than expected numbers, while Verizon, Chevron and Colgate disappointed. On the whole though, more than 70% of companies that have reported so far exceeded earnings expectations. The companies that have disappointed have generally disappointed on top-line sales numbers rather than earnings. This trend of companies beating earnings but missing revenue has been happening for years and yet recently we’ve seen stocks respond more negatively to them. I think the concern among investors is how much more cost cutting can keep earnings growing without stronger revenue growth.

Oil increased this week, closing up 1.7% to $53.20/barrel. The yield on the 10-yr Treasury increased, closing at 2.48% from 2.47% a week ago. The average rate on a 30-yr mortgage increased this week, moving to 4.19% from 4.09% a week ago.

Close Weekly YTD
Dow Jones 20,093.78 1.3% 1.3%
S&P 500 2,294.69 1.0% 2.5%
Oil 53.20 1.7% (1.3%)
10-yr Treasury (∆ in bps) 2.48 1 3

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Market Recap – January 20, 2017

Stocks Down in Inauguration Week

  • Donald Trump inaugurated as 45th President
  • Mixed earnings see markets up today, down on the week
  • What to expect going forward

Donald Trump was inaugurated as the 45th President of the United States this afternoon. This was a very contentious election yet our constitutional republic managed to peacefully transfer power for the 45th time over the last ~240 years. From an investing standpoint, I see some reasons for optimism and some areas for concern with the new administration. Significant reforms to corporate taxes and regulation strike me as a positive while actions that seek to limit international trade through tariffs or others mechanisms seems dangerous.

While the inauguration dominated the news this week (CNBC hasn’t talked about stocks all day) there were some interesting earnings reports. Target downgraded its forecast and its shares are down almost 10% since the announcement. Holiday sales seem to have been a disappointment to many brick and mortar retailers. GE disappointed investors today while Procter & Gamble exceeded expectations and raised future guidance. Both GE and P&G seemed optimistic about future US growth, but were both cautious to comment too much on the incoming administration. Many companies seem to want to see details instead of talking points before commenting or adjusting business plans. This seems to be the best course for investors as well. There’s been a lot of talk out of the incoming Trump administration, some of it contradictory. Now that’s he’s officially the President, we will hopefully start seeing policy specifics and can make investment decisions as such.

The Dow and S&P 500 were both up today, but finished down on the week. The Dow was down 0.3% while the S&P 500 was down 0.1%. This is the second consecutive week the indices declined, but both are still up slightly on the year.

There was an article in Forbes this week about a phishing scam that is happening on Gmail. A phishing scam is how John Podesta’s email was accessed during the election. It got me thinking about online security for your investment and other financial websites. E-trade, and many other financial firms, offer what is called a 2-step authentication process. I set it up on all my accounts this week and encourage you to do the same. Systems differ, but with this level of security, you either receive a text message with a code or use a third party app to create a temporary code to enter along with your password when you login. This means that even if your login and password are compromised, someone won’t be able to access your account unless they also have access to your cell phone. In E-trade, you go to Accounts>My Profile>Security & Passwords. Then click the ‘Manage Secure ID’ link and follow the directions.

Oil declined slightly this week, closing down 0.2% to $52.33/barrel. The yield on the 10-yr Treasury increased, closing at 2.47% from 2.39% a week ago. The average rate on a 30-yr mortgage declined for the 3rd straight week, moving to 4.09% from 4.12% a week ago.

Close Weekly YTD
Dow Jones 19,827.25 (0.3%) 0.3%
S&P 500 2,271.31 (0.1%) 1.5%
Oil 52.33 (0.2%) (2.9%)
10-yr Treasury (∆ in bps) 2.47 8 2

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Market Recap – January 13, 2017

Markets Retreat, Financial Earnings and Corporate Taxes

  • Stocks retreated slightly in the 2nd week of the year
  • Initial financial earnings generally better than expected and optimistic about 2017
  • Is an overhaul of corporate taxes in the works?

Stocks retreated slightly this week in the second trading week of the year. The Dow declined 0.4% while the S&P 500 was off 0.1%. Markets are closed Monday in observance of Martin Luther King, Jr. Holiday.

JP Morgan, Bank of America and Wells Fargo kicked off earnings season today with numbers that generally beat expectations. While the 4th quarter numbers were good, most investors looked to improved future forecasts as the key takeaway. The banks are already seeing the benefit of higher interest rates and they expect economic activity to pick up in 2017. JP Morgan CEO Jamie Dimon noted strength in a number of areas, including wage growth, unemployment, consumer confidence, real estate, etc as the basis for his optimism this year. Next week we’ll start to see major non-financial firms start reporting such as IBM, GE and others. Read More

Corporate taxes are becoming a hot topic in the new Congress. Since we’re going to start hearing more about ‘Border Adjustment Taxes’ I wanted to review the current situation and what this potential change means. The US currently uses a global tax system. This means that the US taxes the global earnings of all US companies. The federal corporate tax rate is 35%, although most companies pay an effective rate below that level. Companies get credits for taxes paid overseas and can delay paying taxes on foreign earnings as long as the profits stay outside the US. We are the only country in the world that taxes global earnings.

House Republicans have an idea to completely overhaul the corporate tax code in ways that seem to have good and bad consequences. The key aspects of the new plan is to lower the tax rate to 20% and only tax US sales less US costs. This is called a ‘border adjustment tax’ which encourages domestic production and exports while discouraging imports. Under this type of system, all sales in the US would be subject to the tax. Expenses incurred in the US would be tax deductible, but expenses incurred outside the US would no longer be deductible. Sales on products exported to other countries would not be taxed.

In a simple example, if Apple sold a $500 phone in the US and it had US costs of $100 and non-US costs of $100, Apple would pay a 20% tax on $400, or $80. That’s the US revenue minus the US costs. If Apple sold two phones for $500 each, one in the US and one in Canada with $200 of US costs and $200 of non-US costs, Apple would pay taxes based on $500 of revenue minus $200 in US costs = $300. The tax bill would be $60. This is because Apple gets the deduction for US costs, but doesn’t have to pay taxes on sales outside of the US. This is how this type plan encourages exports.

There are parts of this plan that are very appealing. This system eliminates companies’ ability to move profits around the globe to low-tax countries because those transactions aren’t counted in the tax liability calculations. It also brings our corporate tax code and tax rate in-line with other industrialized nations. It also potentially encourages more companies to keep producing in the US or even move production back to the US. On the downside, this is effectively a tax on imports, which could cause price increases on a variety of consumer products. This could also cause large disruptions among companies and industries. We can see the difference by looking at companies like Harley-Davidson (almost all manufacturing happens in the US) versus a company like Walmart (most products sold are made outside the US). The proposed system would have drastically different consequences for these companies. Harley-Davidson would see its tax bill decrease because the tax rate is lower and it exports motorcycles to other countries. Walmart on the other hand would see its taxes skyrocket because a large percentage of its costs are buying inventory made overseas, which would no longer be tax-deductible. Some economists believe a plan like this would strengthen the US Dollar, thus making up the losses to retailers, and other large importers, since input costs would decrease. That sounds very theoretical to me and unlikely to happen exactly as planned. If you’ve made it this far, you can see this is a complicated issue and one that promises significant debate if Congress begins to consider this type of plan. You’re also more familiar with the issue than 98%+ of the public.

Oil declined again this week, closing down 2.2% to $52.45/barrel. The yield on the 10-yr Treasury declined again this week, closing at 2.39% from 2.42% a week ago. The average rate on a 30-yr mortgage declined, moving to 4.12% from 4.20% a week ago.

Close Weekly YTD
Dow Jones 19,885.73 (0.4%) 0.6%
S&P 500 2,274.64 (0.1%) 1.6%
Oil 52.45 (2.2%) (2.7%)
10-yr Treasury (∆ in bps) 2.39 (3) (6)

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