Why We Trust Our Discipline, And Not Our Emotions

I’ve purposely waited to send any communication out on what we’re thinking post-election. I don’t know about your email in-box, but with all the investment management firms we receive feedback from, we’ve been inundated with special webinar invitations and whitepapers on “what the election results mean for your investments.”  Quite candidly, I’ve ignored almost all of it.  It feels like slogging through two wheelbarrows full of manure.

If investors learned anything from the past couple of weeks, I hope it is this—no one really knows what events are going to transpire, and no one knows what the market’s reaction to those events will be.

Going into the Election, the consensus was virtually universal that a Trump victory would be bad for markets, and indeed, the stock market had declined for 9 consecutive days through November 4, just two trading days prior to Election Day.  Instead, the “unthinkable” happened, Trump won, and look at what has happened to financial markets in the last 10 trading days (two weeks).

The S&P 500 has gained 4.65%, the S&P Midcap Index has risen 8.58% and the Russell 2000 Index of small companies has surged 13%.  In contrast, gold, the so-called “safe haven,” has dropped -7.4% and interest rates have surged over 0.50%, with the yield on the 10-year Treasury Note increasing from 1.78% to 2.33%.

Needless to say, if you sold all your stocks because of your fears regarding the Election, you’ve pretty much missed out on about one year’s worth of returns in about two weeks.  For what it’s worth, we remember hearing similar rhetoric 8 years ago prior to the election of President Obama.

The bottom line is this—if you allow your emotions to rule your investment decisions, you will pay the inevitable price.  As you will see in the Investment Allocations section below, we didn’t do anything different with the portfolios that you all entrust us with—we simply followed our process.

What’s Likely to Happen Next

I have nothing new to offer here.  Donald Trump is a businessman, and he likely intends to be a pro-business president.  He likely wants to push through a federal income tax cut, simplifying brackets, eliminating the 3.8% surtax on net investment income, possibly eliminating the AMT (alternative minimum tax), and maybe even totally eliminating estate and gift taxes.

There’s no way to know what this all may look like.  What if the top federal rate is reduced from 39.6% to 33%?  For those high earners, this may seem great.  But, what if they eliminate all itemized deductions except for mortgage interest and charity?  That would mean no deduction for property taxes or state income taxes.  That might not be so great for residents in California and New York, two of the highest taxed states in the nation.

Our approach is to deal with it when it happens.  People will continue to turn things that haven’t happened yet (AND MAY NEVER HAPPEN) into “problems.”  There’s no use, as financial writer Carl Richards recently penned, turning molehills into mountains.

The Fed is Behind the Curve

About the only certainty I can think of in coming weeks is the Federal Reserve Board will raise interest rates at their December meeting.  The bond market has already forced their hand, with yields surging the past two weeks.  A non-move by the Fed would likely destroy any credibility that remains with Janet Yellen and company.

The real key will be what does the Fed do in 2017?  Who knows?  Even an increase in the Federal Funds rate of 25 basis points (0.25%) will only bring that rate to 0.50%. It’s not like you’ll be able to go to your bank and instantly get 2% on a one-year CD. That may be still years away.  In general, though, as rates push higher, it will have a negative effect on stock market valuations, the exact opposite of what’s been happening for the past seven years.

Higher Taxes in 2017, For Sure

Regardless of what comes out of Congress under President-Elect Trump, if you are one of 12 million higher-income workers, you’ll be paying as much as $540 more next year and beyond in increased payroll taxes.  Though it has not garnered much attention, the Social Security administration announced a payroll tax increase which starts January 1.  The wage base rises to $127,200, a 7.3% increase on this year’s level of $118,500.

The wage base is the amount of a worker’s pay subject to Social Security tax, which is 6.2%, and the upper limit is known as the cap.  As a result, if your earnings in 2017 are at this level or above, you’ll be paying up to $540 more (as will your employer).  So, if you’re self-employed, the increased tax will be nearly $1100.

While we’re on this subject, the COLA (cost-of-living-adjustment) for Social Security recipients for 2017 will be 0.3%, but this will likely be wiped out for most since the Part B Medicare premium is scheduled to rise 3.9%, going from $104.90 per month to $109.  About 70% of Social Security recipients are eligible for the Hold Harmless provision, which prevents their Medicare premiums rising more than the cost-of-living adjustment.  Not everyone is eligible, though, so some may see their premiums jump to $127 to $134 per month.

Investment Allocations Update

About one month ago, our tactical equity allocations were at about 64%.  Today, they are just under 60%.  But, much has happened in between.  Going into Election Day, we were at 86% invested.  Since then, though, a very short term risk model flipped negative and last week, one of our major models went Bearish.  This was mostly due to the deterioration in monetary components.

So, overall, the evidence is more bullish than not, but a couple of pillars have been removed.  Notably, both our real estate model and corporate high yield bond model have turned negative in the past two weeks.  Today, both the S&P 500 and Nasdaq Composite reached new all-time highs.  So, we have stocks making new highs and corporate bonds diverging.  That’s a sign to stay alert, as the stock market cannot continue to rise indefinitely without the support of the corporate bond market (in my view).

The Presidential Cycle chart we featured last month, courtesy of Ned Davis Research, has been fairly spot on, and its message is continued strength into month end, a drop in mid-December followed by more strength.  It would be unusual for the stock market to have a poor December.

Bottom line, we’re still moderately positive overall, but our junk bond work is negative, so we are much more defensive in the bond market, and that makes us less enthusiastic.

December Periodic Plan Payments

This is a heads up for all of you who receive automatic monthly distributions from your Fidelity IRA accounts.  All December distribution plan payments that are scheduled to occur between December 14 and December 31 will instead be “pulled forward” and processed on the December 8 nightly cycle.  This is to ensure that all 2016 retirement distributions are processed in the 2016 tax year.  Everything will resume to its normal distribution date in January.

The Political and National Divide

This has little to do with financial markets, and much to do with society.  There is much commentary out there on this subject, much of it quite distasteful, but some of it is really good.  I thought I’d share one of the best ones I’ve come across, and it’s apolitical.  It’s from none other than money manager John Hussman, who bluntly is not doing so well in managing money, but had some terrific thoughts on the present situation.  These are quotes I’ve excerpted from his weekly market comments of November 14, 2016.

“If we’ve learned one thing from the recent election cycle, it’s that people on both sides of the political spectrum feel both unheard and even threatened by the views of the other.  Discontent, on either side, is a signal that we’d better listen to each other to understand those differences.  When people feel unheard, their concerns find unexpected and often undesirable ways of expression.  Neither side will do much good for the country by treating the other half of the nation as idiots.

“The first act of wisdom, and the first step toward peace and reconciliation, is for each side to listen, nonjudgmentally, to the suffering – real or perceived – of the other side.  The job of any true leader, indeed, the mark of any true leader, whatever their political persuasion, is to encourage that understanding.

He goes on to say “My friend and teacher, Thich Nhat Hanh once said, ‘To love our enemy is impossible.  The moment we understand our enemy, we feel compassion towards him or her, and he or she is no longer our enemy.  When you begin to see that your enemy is suffering, that is the beginning of insight.'”

Lastly, may I offer this—Maturity is walking hand-in-hand with those when we don’t see eye to eye.  May America get a lot more mature, and soon.

You Wanted Pictures??

A number of you comment from time to time how enjoyable it is when we share pictures of the family and such.  Some of you have also remarked how you have every Christmas photo we’ve sent, going back some 20 years.  I must say that is both touching and honoring.  So, in that spirit, here are some updates from both Steve Medland and myself.

That’s Conrad on the left, and sister Audrey on the right.  Mom and Dad are below, also known as Steve and Kim.  And you all thought Steve just worked on spreadsheets!

Here’s our Queen of Hearts, Caroline.  Now in middle school, a sixth-grader, involved in Girl Scouts, piano, the flute, the oboe, volleyball, horseback riding, and BSF with Mom.

This is big brother, Adam, skating in New York’s Central Park with girlfriend Emma. He’s on pace to graduate next May from New York University with his photo major, and hopefully, a paying job!

Finally, here’s yours truly with wife Michelle.  Yes, I know—I am going to take some ridicule for this, but most of you know I have a pretty good sense of humor.  Your quiz—which one is Tweedledum?

Material of a Less Serious Nature

A wicked Chicago man died and went to the place all wicked people go.  The Devil shoved him in a room and cranked up the heat and humidity.  The man smiled.  When the Evil One asked why the man was smiling he said, “Just like Chicago in Spring.”

So, the Most Evil One cranked up the heat and humidity more.  The man removed his coat, smiled, and said, “Just like Chicago in Summer.”

This time the Destroyer of Beauty cranked the heat and humidity to maximum.  The man removed his shirt and tie and said, “Just like Chicago in August.”

The Devil then got an idea.  He shut off the heat and turned on the air conditioning. The room froze in seconds.  Ice was everywhere.  Polar bears hid in dens because it was so cold.  Satan, confident he had finally won, peaked in the man’s room only to find the man partying frantically. . . . . . .

He was screaming and shouting “The Cubs won the World Series!  The Cubs won the World Series!”

Indeed, the Cubs really did win the World Series.  After 108 years.  Between that happening and Donald Trump being elected President, maybe the message from 2016 is that anything is possible, and we should never give up (No White Flags—see the Gleason DVD we just sent).

From all of us at TABR, may you have a Blessed Thanksgiving.

Sincerely,

Bob Kargenian, CMT
President

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