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Our Latest Thoughts on the Market

Fourth Quarter 2017

by Mark Van Mourick, CEO; Leslie Calhoun, CIO/CCO; and
Bart Zandbergen, Senior Wealth Advisor
Stella Choi, CFP/CFA Dir. Portfolio Management

October 11, 2017


U.S. & World Economy by Mark

Irrespective of the news “noise” and saber rattling, the fuse has been lit for the “Trump Trade” once again. Over the last 4 – 6 weeks U.S. focused stocks, interest rates and the U.S. Dollar have all surged from the doldrums. As we head into the historically volatile month of October, the U.S. economy is finally achieving a 3% GDP growth rate (second quarter revised) and the financial markets are strong. Hopes are gaining for a Federal Government tax reform, which comes at a good time for us Californians who have the highest state income tax, sales tax, gas tax and vehicle tax in the country (according to the Orange County Register). However, our ability to offset these taxes against our federal taxes will be a major battle. As we wrote in our January 2017 newsletter, we believe lower taxes will again help GDP growth and, surprisingly, help with Federal Government deficits as they have done in the past.

While inflation has stubbornly remained below the 2% Fed target, interest rates have started moving upwards in anticipation based on our low unemployment level, increased GDP, pro-business agenda, hopes of tax reform, and the impact of the Fed starting to sell off their $4 trillion holdings. Time will tell if this is the start of a multi-year trend or another false start.

Global stocks (outside of Russia, which did so well last year) have all joined with the U.S. in one of the broadest stock market rallies in recent memory, with global stock indexes up about 15% (according to the Wall Street Journal). All of this has helped our YTD performance (see below) but also raised global valuations to levels which could be unsustainable if interest rates rise more than 100 basis points (or if some part of the world comes unglued). Our response is to both keep our fingers on the tactical “sell” buttons and trust in the historically low volatility of our strategically diversified portfolio models.

Portfolio Management by Leslie

Our third quarter included the sale and return of capital and profits of a direct investment real estate project we invested in during 2013. This was a boon to our investors who followed our advice during scary times to purchase a mostly dark, bank owned retail center when the commercial real estate market was still very depressed and uncertain. For our diversified portfolio models, we continued aligning our accounts to our Trump economy models by adding to our global equity positions on dips, reducing some fixed income exposure and duration while upgrading fixed income credit, and selling out of an under-performing managed futures fund then investing those proceeds into long/short and absolute return funds. We also identified a direct investment real estate project which we offered to clients who could participate and needed to grow exposure to the asset class.

We believe risk is the most important aspect of investing and our conviction stands that a diversified investment portfolio better withstands the ups and downs which are beyond any investor’s control. By nature of investing in diversified and complementary investment sectors, we enjoy healthy returns of all investment sectors while we minimize downside at the time of a potential black swan event or an eventual market correction.

Portfolio Management by Stella

Third quarter had positive returns across all of the assets, even for Commodities and Managed Futures which were the only assets with negative returns YTD. We are showing continuously strong returns in the Real Estate sector for both YTD and QTD. One noticeable change is the Natural Resource Equities sector which had a strong third quarter relative to the YTD return. It was beneficial to be in Non-U.S. securities from both the equities and fixed income sides. Global Fixed Income ranks at the bottom from the YTD and QTD stand point, and we see this as an enduring pattern going forward.

We added another target security to Emerging Market Equities to diversify the Emerging Markets region. This security is using big data to read market sentiments which is an emerging investment strategy. In European Equities, we are replacing a currency-hedged security to a more dynamic stock picking strategy using factor-based models. Furthermore, we replaced the MLP security (which had generic exposure) for a security that focuses specifically on North America. We are experiencing very calm stock market movements which is very unusual for this prolonged period. Our brainstorming ideas are currently focused on how to accommodate for changes when the market decides to break from this long trend.

(These holdings do not include direct real estate returns or Vida returns.)

Holdings 09-30-2017

Financial & Business Planning by Bart

The following are year-end tax tips for highly paid individuals, professionals and/or business owners:

  1. Tax Loss Harvesting: Allowing taxes to dictate your investment strategy is rarely a good idea. But if you’re already considering selling appreciated securities or other assets, cutting them loose by year-end could save you money. If you’re in the 15% tax bracket, you’ll pay 0% on long-term capital gains. Taxpayers in higher brackets should look for losses to offset investment gains. This is called “tax loss harvesting.” Offsetting gains is particularly important to taxpayers in the 39.6% tax bracket.

    Don’t sell shares to lock in a loss with the intention of buying them back right away. The IRS “wash sale” rule bars you from claiming the loss if you buy the same or a “substantially identical” investment within 30 days of the sale.
  2. Beware of Buying Mutual Funds in December: Sometime in December, many funds pay out dividends and capital gains that have accumulated during the year and the payout goes to investors who own shares on what's known as the “ex-dividend date.” It might sound like a savvy move to buy just before that day so you get a whole year's worth of income, but… That's not how it works. Yes, you'd get the payout, but at the time of the payout, the share price falls by exactly the same amount. If you get $2/share in dividends, for example, the share price drops by two bucks. In effect, the fund is simply refunding part of your purchase price.

    But the IRS doesn't see it that way. You have to report the payouts as income on your 2017 return - and pay taxes on them - even if the money is automatically reinvested in extra shares. (Note: The tax threat does not apply to mutual funds held in 401(k) plans or other tax-deferred retirement accounts.) Before you buy shares for a non-retirement account in December, check the fund company's website to find out exactly when the dividend will be paid.
  3. Roth IRA Conversion: If you think your tax rate is going to rise sometime in the future, converting to a Roth IRA makes a lot of sense. Withdrawals from traditional IRAs are taxed at your ordinary income tax rate, while all withdrawals from Roth IRAs are tax-free and penalty-free as long as you're at least 59½ and the converted account has been open for at least five years. Although, you do have to pay taxes on any pre-tax contributions and earnings in your traditional IRA for the year you convert. Worrying about not being able to pay the tax bill? Don’t! When you convert to a Roth IRA you can change your mind. You have until 10/15/2018 to undo the conversion and turn your Roth IRA back into a regular IRA.
  4. Maximum Fund Your Retirement Account:
    a. If you are a W2 employee: The 2017 limits are $18K and $24K if you have the honor of being over the age of 50 years. This does not include any employer match or profit sharing contributions. If you are not on track to max out contributions, contact your HR department. You can have up to 100% of your paycheck contributed to your 401(k) as long as you stay under the limits above.
    b. If you are self-employed, consider:
    i. SEP IRA: One can contribute up to 25% of AGI to the max of $54K for 2017 and have until final tax filing date of 10/15/2018 to contribute.
    ii. Defined Benefit Plan: The limitation on the annual benefit under a defined benefit plan under section 415(b)(1)(A) is increased to $215,000. That means a person of a certain age and income level could fund in excess of $100,000 into this plan and get the current year deduction.
  5. Charitable Giving:
    a. IRS allows a 50% tax deduction for charitable contributions via cash up to 50% of AGI.
    b. If you have appreciated stock or mutual funds, consider donating shares of those. You will get the benefit of 100% deduction without having to sell the asset and pay capital gains. The charity will be able sell the asset and pay no taxes.
    c. Can’t decide on a charity today but had a larger than normal income year (i.e. sale of company, windfall income, etc.)? Consider a Donor Advised Fund (DAF). This fund will allow you to contribute cash or transfer securities in 2017, take the deduction this year, and you will have the rest of your life to parse out proceeds to the charities of your choice.
  6. Penalty Proof Your Return:
    a. If you expect that you'll owe money when you file your 2017 tax return next spring, you can avoid an underpayment penalty by boosting your withholding now.
    b. You needn't pay every penny of the tax you expect to owe. As long as you prepay 90% of this year's tax bill, you're off the hook for the penalty. Or you can escape its reach - in most cases - by prepaying 100% of last year's tax liability.
  7. Plan Your Itemized Deductions: If you expect your income to drop next year (for example, you plan to retire), deductions will probably be more valuable this year. You may want to pay deductible expenses before year-end, such as your January mortgage, 2018 real estate taxes and fourth-quarter estimated state income taxes. Be careful, though: If you're a candidate for the Alternative Minimum Tax, some of those deductions could be disallowed. On the other hand, if you expect your income to increase next year, you’ll want to defer charitable gifts and other deductible expenses because they’ll be more valuable.

Summary:

On the 10-year anniversary of the 2007 S&P 500 market top we pause to reflect on how our economy and markets have changed. At 1.27% GDP growth, we’ve had our weakest 10-year growth ever (according to George Maris at Janus Henderson Investors), yet the coordinated central banks’ “zero rate” policies have re-inflated global asset values to historic highs; this includes a recovery of the S&P 500 from the 666 level in 2009 to today’s 2550 value. However, the world’s top 45 economies are all currently growing and there are no early signs of a pending recession, apart from the longevity and full valuations of our recovery. At Optivest, we are keenly aware that we face investment decisions in an “as-is” economy and are taking every opportunity to optimize the risk/return balance in every portfolio.