INSIDE THIS EDITION:
What Does the Senate Tax Bill Mean for the Economy?
Weekly Technical Comment
Getting Your Finances Ready for Year-End
401k Plan Manager
What Does the Senate Tax Bill Mean for the Economy?
For the better part of the year, taxes have been a hot topic in Washington and on Wall Street with wide ranging implications for the economy and financial markets. With the Senate narrowly approving (the vote was 51-49 in favor) a tax bill over the weekend, the stage is now set for the House and Senate to bring together their visions for tax reform and produce a final bill to be signed into law by President Trump.
What’s in the Senate Bill?
- For individuals, the bill keeps the number of tax brackets at 7. However, it does adjust the tax rates for different levels of taxable income. The tables that follow compare current law with both the House tax plan and the Senate tax plan.
- Like the House proposal, the Senate bill almost doubles the standard deduction. For single filers, it would lift the standard deduction to $12,000 (an increase from $6,350 currently) while married filers would see the deduction increase to $24,000 (an increase from $12,700 currently).
- Also in line with the House proposal, personal tax exemptions would be eliminated.
- In a last-minute change, the Senate also decided to allow a $10,000 itemized deduction for property taxes which is directly in line with the House version of the bill.
- The child tax credit would double to $2,000 (it is currently $1,000). However, if lower income earners don’t owe Federal income taxes, this $1,000 increase becomes a wash as it is a non-refundable increase. That said, child tax credit eligibility is expanded in the Senate bill to include married filers that earn less than $500,000.
- The mortgage deduction would remain in place allowing homeowners to deduct interest paid on mortgage debt all the way up to $1M.
- Home equity loan interest deductions would be eliminated.
- Increases the required time in a home before the capital gains exclusion can be taken.
- The Alternative Minimum Tax remains in place.
- Maintains the estate tax but would double the exemption level
- Medical expense deduction would be kept, but for 2017 and 2018 would have a lower deduction threshold of 7.5%. In other words, medical expenses that exceed 7.5% of adjusted gross income would be deductible.
- Removes the requirement to purchase health insurance.
- Corporate tax rate would drop to 20%, a 15% decline from today’s 35% level. However, this wouldn’t come into play until 2019.
- Make it possible for businesses to expense new equipment. However, this would be phased out over time. Currently, the bill proposes a 20% reduction per year after the fifth year.
- Lower taxes on pass-through business income. This is an important provision as most businesses in the U.S. are set-up as pass-through entities. The Senate bill lowers the pass-through tax by allowing individuals to deduct 23% of their income that originates from pass-through entities. It should be noted that this has some other strings attached tied to income levels to prevent abuses of the pass-through tax provision.
- Multinational corporations would be taxed differently under the Senate bill. Namely, the bill would move corporate taxes to a territorial system where taxes are not paid if earned in other countries. To accomplish this, the Senate bill proposes a one-time tax of 14.5% on cash held abroad and 7.5% on non-cash assets held overseas.
While we don’t know how much of the Senate’s bill will be enacted (the House and Senate need to come together on a unified bill), markets have priced in a final agreement.
Implied Probability of Corporate Tax Cut by March 31, 2018 Nearly 100%
Source: Bloomberg, PredictIt, Goldman Sachs Global Investment Research
For the economy, the Senate bill, if approved as proposed, would likely boost GDP growth, at least temporarily. By what margin however, remains unclear. Despite the short-term GDP improvement that might be expected, some estimates show that the net effect beyond 2020 flattens out. If this scenario plays out, the tax cut could leave much to be desired.
Cheaper Stocks Are Gaining
In last week’s report we entitled our first section “Strategic Opportunity”. The commentary included the following:
“There is a lot of risk right now in focusing on the status-quo, and one of the largest potential mean-reversion opportunities will involve growth and value stocks, where the 16-percentage point outperformance of the former over the latter is the widest since 2000 – the height of the tech bubble (classically late-cycle, and we know the benefit of 20-20 hindsight what happened next…those who ignore the lessons of history….).”
The rotation into cheaper undervalued stocks has begun on the back of the weekend passage of the tax reform package. The relative strength lines in the chart below show the past week’s leaders to be banks (blue line), retailers (red line), transportation (green line), and energy stocks. All of them had been market laggards at the start of the November. They’re now market leaders. All are expected to benefit from a stronger economy, higher interest rates, and lower taxes. Domestically-oriented small cap stocks are also showing relative strength for the same reasons. Technology stocks, which won’t benefit from the tax package, have become market laggards over the past week. Money rotating out of the big FAANG stocks and semiconductors is moving into financials and other less expensive sectors mentioned above. The relative strength lines in Chart 2 show recent underperformance in Facebook, Amazon.com, Apple, Netflix, and Google. Semiconductor stocks are also being sold. On a broader level, the market is experiencing a rotation out of growth and into value stocks.
S&P 500 Value ETF is Outperforming Growth
The rising green line in Chart 3 plots a ratio of the S&P Value iShares (IVE) divided by the S&P 500. Financials are the biggest part of the IVE (28%). The falling red line in Chart 3 is a relative strength ratio of the S&P 500 Growth iShares (IVW) divided by the S&P 500. That shows relative weakness over the past week. Its biggest component is technology (37%).
The so-called FAANG stocks make up a quarter (25%) of that ETF. It’s another way to look at the rotation out of technology into financials, but on a broader level. The black line in Chart 4 is a ratio of the Value iShares (IVE) divided by the Growth iShares (IVW). It too is rising. We saw an earlier version of that rotation during June. An even bigger rotation took place after last November’s election on hopes for a stronger economy with rising interest rates. The passage of the tax reform package appears to be reawakening those hopes.
Energy Shares Rebound
Energy shares are finally showing some bounce. The daily bars in Chart 1 show the Energy Sector SPDR (XLE) climbing above its 50-day average today. The XLE is bouncing off chart support along its late October low and its 200-day moving average. Those are logical chart points for the XLE to start moving higher. [The 50-day average remains higher than its 200-day line which is also a positive sign]. The gray area (which plots a ratio of the XLE divided by the S&P 500) has been slipping over the last two months. But it’s rising today with energy being one of the day’s strongest sectors. That’s probably based on reports that OPEC has agreed to extend production cuts to the end of 2018. Energy shares have lagged behind rising oil prices which recently hit the highest level in two years. It’s time for them to start catching up.
Weekly Snapshot of Global Asset Class Performance
STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)
On the STA Money Hour, daily at 12pm on 950AM KPRC in Houston, we have talked several times about how to better plan for your future. Towards year-end, it is a great time to get organized to start next year on the right foot with the right plan! Below, I have listed some steps that you can take to get your finances ready by year-end.
Also – don’t forget to spend a little time talking with your CPA and Tax Team related to any Year-end Tax Planning ideas after the Republicans (hopefully) pass their new Tax Plan.
- Start to get your budget under control
- Review Credit Card Statements and/or Bank/Debit Card Spending
- Start using Quicken or Mint.com to track expenses
- Start giving yourself a weekly “cash budget” vs. going to ATMs (and stop using non-free ATMs)
- Determine Strategy to pay down debt (and work into budget) – Order
- High Interest non-deductible
- High Interest deductible
- Lower interest
- Note: Feel good about yourself…find a way to pay off lowest balances first and DON’T CHARGE WHAT YOU CAN’T PAYOFF GOING FORWARD!
- Review your FICO Score – see if you can get it improved (myfico.com or other services)
- Plan for discretionary spending items like vacations and Christmas spending and work into budget NOW vs. at time of event.
- Plan to save for longer term goals like new house or vacation house
- Consider refinancing your house if not done already (keep eye on interest rates – up almost 0.50% in last several weeks).
- Update your W4 if you are getting to large a refund or had a surprise tax owed.
- Review at the credit cards you are using to consider:
- Lower interest rates if you carry a balance (see FICO comment as well)
- The Rewards offered – based on usage, more rewards/miles?
- 0% Interest on balance transfers – but track and be careful!
- In your budgeting, don’t forget to determine what you can put into employer plan:
- At least do match
- If not maxing, increase by 1%-2% and work into budget
- Medicare (and ObamaCare) Open Enrollment – are you in the right plan for your needs (healthcare utilization, prescription drugs, change in family situation)
- Employer Open Enrollment for Benefits – Have you picked the right plans?
- Enough Life Insurance
- 401k investments and deferral
- Does HSA Plan make sense?
- Review Your Portfolio – Has it performed to your goal “Hurdle Rate” and benchmark (not necessarily S&P 500). Given outlook are you properly allocated to stocks, bonds or cash.
- Determine, if available Roth vs. Traditional IRA/401k (lower the tax bracket, more Roth makes sense)
- If you are in retirement and/or low income year consider a Roth Conversion. This would need to be done by December 31st (if wrong can always “do over” recharacterize).
- Social Security Maximization Strategies (as you approach 62, FRA and age 70) – maxing with spousal and/or survivor’s benefits.
- Meet with a financial planner to see where you are in terms of your retirement (are you on track) – meet with a fiduciary (not just product pusher), fee-based, CFP, CPA/PFS, etc.
- On Track – Change savings, Hurdle Rate, Goals
- Pension/Social Security Maximization
- Risk Management
- Retirement Budget
- Optimized Tax Distribution Plan in Retirement (like STA’s R.I.T.E Plan™)
- Start college savings plan
- UTMA, 529 Plan, Pre-Paid college plans – START EARLY
- Review and assure year-end 529 Plan distributions (match expenses to distributions)
- Review available Tax Credits/Deductions (many have income limitations)
- Student Loan interest
- American Opportunity Credit
- Lifetime Learning Credit
- Research available grants and/or other financial aid.
Other Planning – Tax, Estate and Risk Management:
- Review your Estate Plan and get a Will done – best if with an attorney, but if you can’t afford an attorney right now, consider online services like LegalZoom (it is better than nothing).
- Sit with your insurance agent:
- Do you have enough life insurance (when considering work)?
- Have you considered or do you have disability and long-term care Insurance?
- Are there in your property-casualty coverages (car, home, umbrella, professional, etc.)?
- Review your 2015 Tax Return and Meet with Tax Team:
- Review these Year-End Tax Planning Basics.
- Consider year-end Charitable Planning – if needed and desired consider Donor Advised Fund (especially if you want to give a lot for tax planning and have not identified charities)
- Review your portfolio’s tax situation and consider Year-end Tax Loss Harvesting and “Tax Placement” changes between your retirement and taxable accounts
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