An optimistic start to the new year

With a March 2020 COVID-induced market bottom in the rear-view mirror, global equity markets raced ahead over the next twelve months, setting new highs and finishing a solid first quarter of 2021. The S&P 500 index (U.S. Large Cap stocks) gained 56.4% over the past twelve months and 6% during the past three months. It set 17 new highs in the first quarter of 2021 alone and reached the 4,000 level for the first time. Mega-cap technology companies drove returns at first, part of the Work-From-Home trade that characterized so much of 2020. As the year wound down, it became apparent that the Democrat-controlled Federal government would make good on its promises of increased fiscal spending alongside continued monetary stimulus from the Federal Reserve.  With that uncertainty gone, prospects shot up for a much stronger U.S. economic recovery, and economically sensitive stocks such as U.S. Small-Caps assumed the leadership mantle. As measured by the Russell 2000, U.S. Small-Cap stocks were up 95% over the past year and up almost 13% for the past quarter. International stocks have a greater proportion of cyclical stocks than the U.S. market, which along with increased stimulus from overseas central banks/governments and a weaker dollar, pushed them higher. For the past twelve months, Foreign developed (Europe and Japan) gained 45%, while Emerging Market stocks returned 58%. U.S. real estate (equity REITs) made a strong comeback, as well, up almost 9% and 38%, respectively, for the past 3- and 12-months.

Bonds made headlines in the first quarter of 2021, but not in a good way. Afraid that inflation would pick up with strong economic growth, Treasury bond investors sold off the 10-year bond. This liquidation pushed its yield up to 1.75% at the end of the quarter, an increase of 0.84% and the biggest one-quarter gain since 2016. Prices for broader U.S. investment-grade bonds, including corporate bonds, declined as well, dropping 3.4% during the quarter. U.S. municipal and international bonds (USD hedged) held up much better.

What is your BFA Investment Committee’s outlook for the rest of the year?

Your BFA Investment Committee believes that forecasts for more robust global growth particularly bode well for equities outside of the U.S., which are already undervalued compared to U.S. stocks. Our clients should thus benefit from their allocations to foreign stocks. We will also continue to keep an eye on any rising prices for goods and services. U.S. households are flush with cash from fiscal stimulus.  Those savings, in addition to pent-up demand stemming from COVID-19 restrictions, could unleash inflationary pressures not seen for a long time. We also believe that the Federal Reserve may have to confront increasing bond yields. The Fed has been content to let market forces play out, but a steeper yield curve may force the Fed to push back more forcefully. Finally, our clients should benefit from a diversified fixed income portfolio, going beyond core bonds to take advantage of higher yields, geographical diversification, and the shelter of taxable income when practical. 

Financial Planning Concepts

Biden Tax Proposals – Forewarned is Forearmed!

U.S. tax rates today are among the lowest U.S. citizens have ever experienced. But the newly unveiled $2.3 trillion (with a “T”) infrastructure plan will require some significant revenue to offset the spending. Taxes are once again front and center, so it is time to revisit key components of President Biden’s proposed plan. Nothing is permanent yet but “forewarned is forearmed” and we want you to be ready.

1. Corporate tax increases seem most likely. The President has had a long-standing commitment to increase corporate taxes. The corporate tax rate could increase from 21% to 28% and there could be an increase in taxation of international corporate income earned by U.S.-based companies. These increases could take effect as early as January 2022. According to Forbes, analysts from Goldman Sachs have predicted that Biden’s entire tax plan would reduce 2022 earnings-per-share on the S&P 500 by 9%. 

2. Is your net worth greater than $3.5 million? Unified gift and estate tax exemption amounts could decrease from $11.58M to $3.5M for individuals and $23.16M to $7M for married couples. There is talk of doing away with several common estate planning strategies like GRAT’s, family limited partnership discounts, and limiting dynasty trusts and defective trusts, all very effective tools for high-net-worth families. Planning tip: Consider aggressively gifting now, since there are no claw-backs on the gifts. Review all trusts and estate plans and potential estate tax changes and consider setting up trusts now. Life insurance could help if illiquid assets exist in your estate and taxes remain a concern. 

3. Do you own taxable assets that have appreciated in value? The new plan could eliminate the step-up in basis at death and potentially create a taxable event at that time. While this could be the most challenging of all to pass, it could also be the most impactful. Planning tip: Consider “basis management” as an ongoing strategy to bring down gains in your portfolio, particularly if the step-up in basis is eliminated. This may include paying more attention to annual rebalancing, placing stocks that are anticipated to appreciate into retirement accounts and transferring low-basis stocks to lower-income family members (up or down). 

4. Is your income above $400,000? Watch for an increase of the top ordinary income tax rate for income over $400,000 to 39.6% from 37%. Planning tip: Consider all strategies to bring down income, including funding traditional retirement plans, opening profit sharing/defined benefit plans, bunching deductions, etc. There may be an increase in long-term capital gains rates from 20% to 39.6% on income $1,000,000 and over, plus the Medicare Tax of 3.8% on top of those amounts. 

5. Tax-deferred exchanges for real estate performed under IRC 1031 may no longer be available. IRC 1031 applies to like-kind real estate. Planning tip: Consider performing like-kind exchanges this year to defer the gains, but make sure that any transaction qualifies under any tax law changes. 

Global equity markets continued their recovery in the third quarter of 2020.

The S&P 500 index (U.S. Large Cap stocks) finished the third quarter up almost +9% and set a new record in the process. Year-to-date through September 30, the S&P 500 is up +5.6%. The largest technology companies comprise almost 25% of the index and drove returns. For example, Amazon.com Inc. is up +70.4% year-to-date while Apple Inc. is up +58.6% year-to-date. Other index components have more room to go to recover their losses from earlier in the year. Assuming every holding in the S&P 500 has equal weight, the index was up +6.8% for the quarter but down -4.8% year-to-date. U.S. Small Cap stocks gained +5% for the quarter. Equity gains were not limited to U.S. stocks, as Foreign developed (Europe and Japan) stocks were up almost +5%. Emerging market stocks outperformed their U.S. and foreign developed counterparts during the quarter, gaining +9.6%. A continued weakening of the U.S. dollar (-3.6% for the quarter) boosted Foreign stock returns. Non-investment-grade (i.e., high yield) U.S. corporate bonds continued their recovery, gaining almost 5% during the third quarter.

Finally, U.S. Core and International bonds were up +0.6% for the quarter. The 10-year Treasury yield barely nudged during the quarter, ending at 0.68%.

Here are the broad index returns through the Third Quarter of 2020*:

What does the BFA Investment Committee think will drive volatility for the rest of the year?

We expect market volatility to pick up as we get closer to the U.S. Presidential and Senate elections. The markets do not like uncertainty, and the election results may not be final until days or months following the actual voting. While the markets may react negatively to these developments, we believe the reaction will be short-lived. Research shows that the political party in power, either in the Presidential or Congressional branch, is not a major market driver. We also expect an increase in market volatility if the U.S. government does not provide further fiscal stimulus. Chairman Jerome Powell of the U.S. Federal Reserve has been quite vocal about the fragility of the economic recovery and the need for ongoing fiscal stimulus in addition to the monetary stimulus provided by the Federal Reserve. Many investment analysts and economists expect Congress to reach a deal, even if it means doing so after the election.

Volatility could also pick up if the global economy, particularly the U.S., cannot sustain the recovery.

Most economists expect a significant bounce in third-quarter U.S. Gross Domestic Product (GDP). Still, there is concern that employment will not reach pre-pandemic levels for several years, and thus, consumer spending will taper off. However, the Federal Reserve has promised to continue its extremely supportive monetary policy. Global governments and central banks have learned valuable lessons from their initial responses to COVID-19 and should continue to act expeditiously to support their economies. Finally, work continues on a COVID-19 vaccine. Although there is uncertainty around when and how the vaccine will be safely distributed worldwide, unprecedented cooperation between global governments and private corporations has given both citizens and investors hope for economic activity accelerating to pre-pandemic levels. Given these challenges and opportunities, your BFA Investment Committee is cautiously optimistic and maintains its portfolio allocations and fund line-up. We are currently holding cash in place of U.S. high yield bonds, and it could be early next year before we re-enter the U.S. high yield corporate bond sector.

We will increase our focus on tax planning in the fourth quarter for client portfolios. Mutual funds are required to distribute their realized capital gains by year-end, with most of those distributions occurring in December. We will analyze our client holdings for material distributions (i.e., 5% or more of net asset value) and may take action to avoid those distributions. We will also look for opportunities to harvest further capital losses in client portfolios. Given the specter of higher capital gain taxes, loss carryforwards have become even more valuable. These actions could save on taxes for you.

You Are Not Alone

Is there any question that “The Year 2020” will go down as one of the most challenging times in history? Certainly not. But you may wonder why you feel so out of sorts. You should know that most of us are experiencing a nagging sense of disorientation about ourselves and the world around us. It is with good cause.

Consider the stressors we are all experiencing: The pandemic is resurging in many states when we thought the worst was behind us. Most of us are beyond tired of social distancing, and the uncertainty surrounding an effective vaccine seems to add little hope. To add insult to injury, the economy has suffered tremendously under the weight of social distancing strategies, is showing timid signs of recovery and there are millions out of work. While you may not personally experience it, you know it is there and you can feel it.

And now the election is here. The current state of politics in America creates its own burden of mental uncertainty. Deep inside, we all know that there are many things that need fixing in the U.S. and are eager to get something done. But collaboration is difficult in a winner-take-all, zero-sum game. Is there any real solution?

More than any other time, you should know that there is hope. In difficult times, you will hear people seek hope by quoting the Bible saying, “This too shall pass.” While somewhat accurate in sentiment, the phrase is not actually in the Bible. However, there is a scripture that says, “Rejoice in hope, be patient in tribulation, be constant in prayer.” Tribulation is inevitable but we can celebrate in that true hope of a better future; chances are, you are among the fortunate ones now. With patience (and a little time) we WILL see it pass. And through prayer, all of us can find peace, compassion, grace and, of course, hope.

Most of all, we need to care for one another, and we want you to know that we care about YOU. If you are inclined to get in touch and share your uncertainties about the future, we can promise a deep interest in your situation and your concerns. We may not have all (or any) of the answers. But there are times when a good conversation about what is important in life can result in better insights, and sometimes, a sense that we are not alone in our uncertainties.

We look forward to talking with you again soon!

*U.S. Large Cap=S&P 500, U.S. Small Cap=Russell 2000, Overseas Stocks=MSCI EAFE, Emerging Market Stocks=MSCI Emerging Markets, U.S. Bonds=Barclays Aggregate Bond Index, International Bonds=Barclays Global Aggregate ex-U.S. USD-Hedged, US Real Estate=MSCI US REIT: Data Source: Morningstar®. Allocations=Morningstar® U.S. Fund Allocation Categories: Data Source: Morningstar®. Index returns are for illustrative purposes only and do not represent actual performance of any investment. Client returns will differ from the results shown. Index performance returns do not include any management fees, transaction costs or expenses. The performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate; thus an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than return data quoted herein. Indexes are unmanaged and one cannot invest directly in an index. Please review your allocation regularly and notify BFA immediately if your circumstances should change. The foregoing content reflects the opinions of BFA and is subject to change. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct.

The equity markets made a dramatic recovery in the second quarter of 2020.

The S&P 500 index (U.S. Large Cap stocks) finished the second quarter up 21%, its biggest quarterly gain since 1998. As of the end of June, the S&P 500 was only 3% below its value at the beginning of 2020. The largest technology companies drove returns, although the rally became more widespread as the quarter progressed. U.S. Small Cap stocks did even better during the quarter, up 25.4%. Foreign developed (Europe and Japan) and Emerging market stocks had stellar quarterly returns, as well, up 14.9% and 18.1%, respectively. They outperformed their U.S. counterparts in late-May and June in part due to a weaker U.S. dollar boosting foreign stock returns. Even non-investment-grade (i.e. high yield) U.S. corporate bonds gained 9.6% during the quarter. These returns are remarkable given the world-wide economic downturn and global economies continuing to struggle with re-opening businesses given continued spikes in COVID-19. Additionally, racism and inequality protests around the world stole the headlines from COVID-19 during the quarter but the markets continued to march on.

U.S. Core and International bonds had an uneventful second quarter, gaining 2.9% and 1.8% respectively, and bond yields continue to be at historic lows. The 10-year Treasury yield is 0.66% on June 30th.

Here are the broad index returns through the Second Quarter of 2020*:

Why are equity investors so optimistic?

The unprecedented intervention by global central banks and governments to assist businesses and individuals during the pandemic have given investors the confidence to re-enter risk assets such as equities and corporate credit. Along with familiar interest rate cuts and quantitative easing programs, central banks like the U.S. Federal Reserve have implemented “new” tools such as the outright purchase of bond exchange-traded funds (ETFs). Global governments have also responded with massive stimulus spending. In fact, most economists and investment analysts expect a second-round of stimulus from the U.S. Congress by the end of summer. Time will tell.

Investors are also anticipating a speedy recovery and an effective vaccine but could be disappointed. Unfortunately, business re-openings are having spotty success and the unemployment rate is not expected to be back to pre-recession levels for another couple of years. Additionally, many health care professionals, health care stock analysts, and economists do not believe that a vaccine is imminent. It could still be another 8-10 months before a vaccine is ready and available for global distribution. Cautious optimism is likely best right now.

What is the BFA Investment Committee’s outlook and strategy lately?

We believe that current U.S. equity valuations are excessive and that volatility in equities will increase as reality sets in for investors. Data suggests that this will be a much?more drawn out recovery than originally expected. Thus, we are anticipating a correction (i.e. 10% or more drop in value) by year-end in US equities. We are currently holding cash in lieu of U.S. high yield bonds and it could be early next year before we re-enter the U.S. high yield corporate bond sector. Also, we believe that Emerging markets, particularly those in Asia, are poised to outperform U.S. and foreign developed stocks. They should continue to benefit from positive structural changes, including participation in “new economy” sectors such as digitalization and technology and from revamped regional trade agreements which will help smooth out bumps in the supply chain. Valuation discounts of emerging market equities to U.S. equities are at all?time highs and the portfolio is weighted appropriately.

The recovery in equities during the second quarter gave us the opportunity to identify those Equity allocations that had grown above their maximum weights. We sold Equities and purchased Fixed Income to bring the Equity allocation back down to its target weight (i.e. sell high and buy low) and to protect the gains that you have recently realized. We also added a new investment-grade bond fund in U.S. core bonds that should boost yield in our fixed income portfolios while maintaining that sector’s role as ballast for the portfolio.

Finally, as a fee-only fiduciary firm, we always have your best interest at heart and believe in full disclosure of our compensation. To this end, we have included a copy of our new Client Relationship Summary, on file with the SEC and in plain English, which provides a summary of our relationship with you, our clients. Please review it and let us know if you have any questions. Also, please let us also know if there are any changes in your financial situation or investment objectives or if you wish to impose, add, or modify any restrictions to your accounts.

As 2020 rolls on, we know that a number of uncertainties in the markets, economy, and political landscape continue to exist. Please know that your BFA Investment Committee continually monitors these landscapes and will make any adjustments as necessary. If you have any questions or need reassurance, please let us know. We look forward to talking with you again soon!

*U.S. Large Cap=S&P 500, U.S. Small Cap=Russell 2000, Overseas Stocks=MSCI EAFE, Emerging Market Stocks=MSCI Emerging Markets, U.S. Bonds=Barclays Aggregate Bond Index, International Bonds=Barclays Global Aggregate ex-U.S. USD-Hedged, US Real Estate=MSCI US REIT: Data Source: Morningstar®. Allocations=Morningstar® U.S. Fund Allocation Categories: Data Source: Morningstar®. Index returns are for illustrative purposes only and do not represent actual performance of any investment. Client returns will differ from the results shown. Index performance returns do not include any management fees, transaction costs or expenses. The performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate; thus an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than return data quoted herein. Indexes are unmanaged and one cannot invest directly in an index. Please review your allocation regularly and notify BFA immediately if your circumstances should change. The foregoing content reflects the opinions of BFA and is subject to change. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct.

The markets keep rolling along. Every asset class finished the first half of 2019 with gains.

After a rough May, stocks rebounded in June and the S&P 500 index (U.S. Large Cap stocks) turned in its best first-half performance since 1997. Real estate stocks continued their winning streak, as well, with both U.S. and Global REITs up 16-17% year-to-date. During the same time, U.S. Core bonds were up over 6% and Foreign and Emerging market stocks gained 14% and 11%, respectively. Even commodities participated in the rally, earning 5% over the first six months of 2019.

Bond and stock investors have diverging views of the U.S. economy. In June, the Federal Reserve discarded their “patient” stance and hinted they would lower rates by year-end. There are two ways to interpret this news: U.S. bond investors have focused on a looming recession, continued low inflation, and possible interest rate cuts. The demand for bonds has significantly lowered bond yields. U.S. stock investors, on the other hand, have viewed mixed economic indicators through rose?colored glasses, are anticipating an end to the trade wars and have driven stock returns to record levels. Only time will tell who is correct.

Economic Outlook

The U.S. economy is slowing down.

In July, the current U.S. economic expansion became the longest in U.S. history. However, signs of slowing momentum continue to mount as evidenced by the gradual decline in the annualized U.S. Gross Domestic Product (GDP) figures for the past 12 months:

2018 – Q1: 2.2%, Q2: 4.2%, Q3: 3.4%, Q4: 2.2%
2019 – Q1: 3.1%, Q2: Various analyst estimates for 2nd quarter 2019 GDP are still positive but in the sub-2% range.

Global economic growth is slowing, as well.

Like the slowing U.S. economy, global economic growth projections continue to be revised downward due to threatened tariffs, or those already in place, driving reductions in trade. Brexit (the divorce between the United Kingdom and the European Union) and its October deadline have also raised trade worries in the European markets. In response, global central banks have begun to lower interest rates and/or ease financial conditions. Despite the short-term risks, however, attractive valuations suggest that investments in European and emerging-market stocks will still significantly outperform U.S. stocks over the next five to 10 years.

Global economic reports continue to be mixed but you can count on the media to focus on the bad news. Recessions and their corresponding market declines are inevitable, but it is impossible to forecast when a recession will hit. We will continue to monitor the economic and market environments for you and will adjust as needed.

*U.S. Large Cap=S&P 500, U.S. Small Cap=Russell 2000, Overseas Stocks=MSCI EAFE, Emerging Market Stocks=MSCI Emerging Markets, U.S. Bonds=Barclays Aggregate Bond Index, International Bonds=FTSE WGBI, Commodities=Bloomberg Commodity, US Real Estate=MSCI US REIT, Global Real Estate=S&P Global REIT: Data Source: Morningstar®. Economic Data: Litman Gregory Analytics and Vanguard Investments. Allocations=Morningstar® U.S. Fund Allocation Categories: Data Source: Morningstar®. Tax Planning Data Source: KPMG 2019 Tax Planning Guide. 1“Important”: ssa.gov/oact/NOTES/as120/LifeTables_ Body.html, 2https://www.onefpa.org/MyFPA/Journal/Documents/March2017_Contributions_Blanchett.pdf#search=annuity. Index returns are for illustrative purposes only and do not represent actual performance of any investment. Client returns will differ from the results shown. Index performance returns do not include any management fees, transaction costs or expenses. The performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate; thus an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than return data quoted herein. Indexes are unmanaged and one cannot invest directly in an index. Please review your allocation regularly and notify BFA immediately if your circumstances should change.