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STA Weekly Report – Q1 2018: Economic Activity Only a Government Could Achieve

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INSIDE THIS EDITION:
Q1 2018: Economic Activity Only a Government Could Achieve
Could Fewer Publicly Traded Companies Lead to Better Returns For Active Investment Managers?
Weekly Technical Comment
Are You Ready for Tax Day?
401k Plan Manager  (*Recently Updated 401k Plan Manager)

 

US stock market volatility returned in the 1st quarter of 2018 with a vengeance. The January to February selloff took most major averages down in the double-digit range (over 10% drop). The stock market peaked within days of President Trump’s State of the Union Message in which he claimed credit for the stock market high. The Federal Reserve then proclaimed such good times as to raise their economic outlook and increase the likelihood of interest rate hikes. We also saw over $100 billion of retail money flood into the market in January, as greed got the better of the crowd. In addition, the market was buffeted as possible trade wars became front and center, technology shares came under pressure as news of Facebook’s data collection unsettled investors, as well as, the President putting Amazon in his crosshairs, and the departure of key White House officials.

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There have been six market corrections, including the current one, during the current bull market. Since 2009, the S&P 500 has fallen an average of 14% in the last five selloffs and the average correction period was about 200 days. There have only been just over 60 days since the recent peak on January 26. Amazingly, during 2016 and 2017, the S&P 500 went numerous stretches without a 1% up or down day. However, the markets are now in a higher volatility environment.

From January 1, 2018 through March 28, 2018 (Q1), real GDP likely grew $110 billion (a 2.5% rise on an annualized basis).  However, the fly in the ointment…according to the Treasury, from Jan 1, 2018 through March 28, 2018 (Q1), federal debt rose by an astounding $621 billion dollars (a 13.1% increase on an annualized basis).  The chart below shows the quarterly change in federal debt versus the quarterly change in real GDP since 2000.  Q1 2018 saw the second largest quarterly growth in federal debt, only surpassed by the massive free spending of Q4, 2008.

Source: Bloomberg/STA Wealth Management

Or, if we just subtract the quarterly growth in federal debt from the growth in real GDP…chart below.

Unfortunately, Q1 2018 is one of the worst quarters on record with the growth in federal debt doing laps around the “growth” in Gross Domestic Product (which of course counts all the federal debt fueled activity?!?).  Incurring over $621 billion in new debt (to be serviced ad infinitum) to produce just over a $100 billion in new economic activity is something only government could achieve.

Source: Bloomberg/STA Wealth Management

However, it gets downright miserable if you add in the massive $500 to $750 billion quarterly growth of unfunded liabilities (UL) alongside the growth in federal debt.  Together, the UL’s and federal debt are rising $3 to $4 trillion annually while GDP is rising around a half trillion.  The tax cuts and fast rising costs of social programs will continue to see deficits rise far faster than economic activity or resultant tax revenue.

How this can be reason for celebration…well, I guess it’s all a matter of perspective.  The US can never grow its way out of this hole…but the Fed and federal government is the best leadership money can buy…for now.  

We would not jump into the market and we remain at more conservative equity levels. We would recommend trimming or rebalancing on market advances. Caution remains recommended for investors.

 

Since peaking in the late 1990s, the number of public companies in the U.S. has been on a steady decline. In 1996, over 7,400 companies were listed on U.S. stock exchanges; today, that figure has been cut in half. What this means is that today there are fewer listed companies than there were in 1976, even though gross domestic product (GDP) is three times larger now than it was then. In contrast, the rest of the world has seen an increase in the number of listed companies from less than 15,000 to near 40,000 over the same period.

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Not only are the number of public companies down, their share-counts have also seen a gradual reduction since the financial crisis. In fact, Citigroup estimates that common shares outstanding for S&P 500 companies have shrunk at a rate of between 0.5% and 1% since 2010. Much of this can be attributed to the growing amount of share buyback programs announced by publicly traded firms.

The shift we have seen is not limited to large cap S&P 500 companies however. In fact, the S&P 500 has seen the least amount of impact from these changing dynamics. The most meaningful shift has occurred in the small- and micro-cap universe where much of delisting actions, both voluntary and involuntary, have taken place. Consider that in November 1997, there were more than 2,500 small stocks and nearly 4,000 microcap stocks publicly traded on U.S. stock exchanges. By the end of 2016, fewer than 1,200 small- and just under 1,900 micro-cap stocks were left.

While there are fewer public companies overall, the size of those remaining has grown. The average market capitalization of U.S. listed companies is $6.9 billion in 2016, compared to $1.7 billion in 1996 and $0.6 billion in 1976 after adjusting for inflation. The growth of the largest public companies has increased market concentration with the largest 1% of U.S. public companies now representing 29% of total market capitalization.

The implications of these structural changes in U.S. markets loom large for investors. For example, because remaining large cap companies tend to be fewer, larger, more mature, and often have more analyst coverage, equity markets have become increasingly more efficient. As a result, return dispersion in stock returns—the average difference in monthly returns across all stocks—has declined and has helped fuel the growth of passive strategies such exchange-traded funds and index mutual funds as stock picking has become much more competitive and has made generating excess returns more difficult. However, the pendulum is likely to swing too far in this direction. We think this will ultimately open the door for active managers to shine.

Since ETFs and index funds buy stocks based on a pro rata basis (weight of market capitalization), rather than fundamentals, the rise of passive investing is likely to make stock prices deviate from their intrinsic value and will allow active investors that follow a sound discipline to capitalize.


 

Major Stock Indexes Retest Underlying Support Levels

Stocks started the second quarter under heavy selling pressure. Some major stock indexes saw losses in excess of 2%. Monday’s selling resulted in retests of important underlying support levels. Chart 1 shows the Dow Industrials touching its 200-day average but closing above it. At its low for the day, the Dow also came dangerously close to its February intra-day low at 23,400.

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Chart 3 shows the Nasdaq Composite Index moving closer to its 200-day average. All market sectors ended the day in the red with eight of them suffering losses of more than 2%. Consumer discretionary and technology stocks were among the day’s biggest losers. Most sector SPDRs are also nearing retests of underlying support levels. The only bright spots today were Treasury bond prices and gold. The CBOE Volatility (VIX) Index climbed 18% to 23, but remains below its March high. The testing process continues. Stocks started the week on a bad note. How they end the week may be more important.

Chart 2 shows the S&P 500 closing slightly below its 200-day line. It’s also moving closer to its February low.

Chart 3 shows the Nasdaq Composite Index moving closer to its 200-day average.

All market sectors ended Monday in the red with eight of them suffering losses of more than 2%. Consumer discretionary and technology stocks were among the day’s biggest losers. Most sector SPDRs are also nearing retests of underlying support levels. The only bright spots today were Treasury bond prices and gold.

MSCI Emerging Markets Index Experiences Bearish Cross

Our risk management discipline in the tactical strategy calls for reducing equity exposure when we see the 20-day exponential moving average cross below the 50-day exponential moving average. In last week’s technical commentary, we discussed how the S&P 500 had experienced this cross. We have now seen the MSCI Emerging Market Index experience this cross. Investors may consider reducing exposure or rebalancing to capture gains and/or reduce risk.

Weekly Snapshot of Global Asset Prices

If you have any questions, please feel free to email me at luke@stawealth.com.

Luke

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)


Are YOU Ready for Tax Day?
Written by: Scott Bishop

With Tax Time in less than two weeks (April 17th this year), we wanted to refer you to a lot of great information on the STA Wealth website. This is especially important given the new tax law (The “Tax Cuts and Jobs Act”) that was passed in December 2017. As we know it is hard to find good information, we took the liberty of organizing Timely Website Tax Related Articles below.

In addition to the deadline for filing your taxes (or for an automatic extension), tax time is a great time to discuss the tax impact on your Financial and Retirement Plan.  We are in the process of updating our Retirement Survival Guide for 2018 to include the new tax law…See what Exert CPA Ed Slott has to say in the forward he wrote for the updated Guide.

I’ll also be reviewing Ed Slott’s “2018 Retirement Decisions Guide” and discuss some of Ed’s “125 Ways to Save & Stretch Your Wealth”.  Tune into the STA Money hour this Friday at 12pm on 950AM KPRC Radio in Houston to hear Ed’s tips and strategies.

Tax Rates and Deduction Levels:

  1. Summary of Individual Tax Law changes related to the Tax Cuts and Jobs
  2. Summary of Business Tax Law changes related to the Tax Cuts and Jobs
  3. Our Key Numbers for Tax Planning, Brackets, deduction levels, Great detailed information in one place.
  4. Our Tax Preparation Checklist to make sure you are organized to report your income and take all your deductions
  5. Key Tax Dates for Retirees – Mostly Tax Don’t miss these deadlines!
  6. Hurricane Harvey Disaster Tax

Tax Issues and Planning:

  1. New Tax Strategies for Roth IRA Conversions given the new
  2. If you are looking to rollover your retirement plan, don’t make any mistakes as you can trigger severe tax Here is a good summary of the Top 10 IRA Rollover Mistakes and on the 60-Day Rollover limitations.
  3. Ready to take your Required Minimum Distribution (RMD), avoid these Dangers and
  4. Claiming Tax Free 529 Withdrawals – did you get a 1099-Q?
  5. If you are looking to roll your IRA to a Self-Directed IRA, avoid these Tax
  6. have an article discussing the Net Unrealized Appreciation (NUA) Tax Planning
  7. Rolling over After-Tax Dollars from your 401k Plan – here are good tax planning opportunities/options to
  8. If you are in for a high tax year, consider some Tax Efficient Charitable Planning or other Charitable Giving.

Articles from “In the News”:

At STA Wealth, we get a lot of requests from the media to help in many areas. You can find these at STA In the News. Many of these are related to tax planning. Here are some highlights:

  1. CNBC – Last Minute Tax Tips based on New Tax
  2. Prudential – 4 Tax Planning Tips for Retirees.
  3. Bloomberg – How to Game Next Year’s Taxes Now
  4. MarketWatch – How to Claim your Tax Break for Charitable Donations under New Law
  5. MarketWatch – 5 Ways the Tax Bill will Affect Your Retirement.
  6. Washington Post – Seven Money Moves by Year End – it may be too late for 2017, but start planning for
  7. Investopedia – “Top 10 Mistakes to Avoid on Your Roth IRA”. If you opened, contributed to or converted to a Roth IRA, here are some mistakes to
  8. Washington Post – “Saving and Spending your Tax Refund” – What should you do with your refund?
  9. New York Times – “Tax Refund as a Financial Opportunity” – Can you get your finances back on track with your refund?


Disclaimer:

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.

Financial Planning and Investment Advice offered through STA Wealth Management (STA), a registered investment advisor. STA does not provide tax or legal advice and the information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters or legal issues, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

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