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STA Weekly Report – An Update on Earnings

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An Update on Earnings
Strategies for Managing Concentrated Stock Positions
Weekly Technical Comment
Planning for Retirement the R.I.T.E Way
401k Plan Manager

This year has been mixed for the different sectors of the market. Cyclical stocks, Technology and Energy have all advanced, with Technology doing the best. However, the other six sectors have all lost ground, with Non-Cyclical stocks losing double digits. Last week was more of the same, with Technology advancing while six other sectors moved lower. Energy has been in ascendance in the last six months and we see potential opportunities emerging in refiners and exploratory companies.

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Earnings continue to pour in and the vast majority of announcements are exceeding estimates. Historically, if more than 70% of companies beat estimates it is a good quarter. The largest companies found a new formula for success in the first quarter: larger pretax profits and smaller tax bills. More than half of the combined net-income growth reported by 200 large public companies can be attributed to lower effective tax rates.

Chip giant Intel Corporation’s (INTC) pretax profits rose $1.2 billion over the first quarter 2017 – but tax expenses fell $294 million. Defense contractor Lockheed Martin Corp. said pretax profits rose $325 million in the March quarter while tax costs fell $43 million.  The tax savings are helping to drive profits to new highs among companies in the S&P 500 index. Overall, first-quarter after-tax earnings for index companies are on track to rise 25.3% over the same period in 2017.  That would mark the seventh straight quarter of per-share profit growth and the strongest gains in seven years.

A cut in the U.S. corporate tax rate to 21% from 35% was the centerpiece of the federal overhaul that was passed in December. Clearly, it is not just the economy driving corporate profits. Change in tax policy is part of it.

In spite of this the market is not making any headway and as we pointed out last week, many stocks are losing ground after the great reports.  The overall sentiment suggests, as we have been saying, that all of the good news was already priced into the market. The market is facing several headwinds. Valuations remain lofty and the Fed is reducing its balance sheet. The Fed reiterated they will continue to raise rates. We also face the uncertainty of trade negotiations and possible trade wars. Lastly, we should not expect an immediate rebound in stocks since market corrections, like the current one, usually last about 200 days.

We do not see any major change in our indicators and believe it is wise to avoid being overly aggressive in equities.

A Note on Bonds
Treasury bonds finally had a good week. Long Treasuries advanced 0.3 percent but corporate bonds took their cue from the stock market and slipped. All major U.S. bond sectors are down this year, with longer bonds leading the way. The two-year treasury has seen its yield almost double since last fall and it is drawing interest from conservative investors.

The Federal Reserve Open Market Committee met last week and they indicated they will continue to gradually increase the Fed Funds rate. They expect economic conditions to evolve and they remain committed to maximum employment and price stability. Currently, inflation is about 2% and even though wages are heading up, they have not been accelerating.

Many have given up on bonds but they may present an opportunity few are expecting. We would continue to hold high quality, moderate duration bonds.

Strategies for Managing Concentrated Stock Positions

Investors may find themselves in a situation where they have inherited a large concentrated stock position, built a concentrated stock position via equity compensation plan, or through the sale of a business to a publicly traded firm. Concentrated stock positions can oftentimes represent a large percentage of an investors personal wealth, and as a result can introduce significant risks to an investors financial position. Take for example what we saw in 2016. According to S&P Global Market Intelligence, several companies that represented concentrated stock positions for investors declined in value by more the 30%. Endo International for example, fell 73.1% during 2016.

As a result, if you are an investor with a large part of your wealth in a concentrated stock position, the risk of a large stock price decline should be mitigated. Fortunately, there are several strategies that can be used to help you prudently divest your concentrated stock position, better

diversify your portfolio, and of course manage your overall risk.

Hedging Concentrated Stock Positions

Tools that can protect an investor from large stock declines can be invaluable. One tool, options contracts, can be used for this very purpose. For example, by purchasing put options, the buyer (the owner of a concentrated stock position in this case) of those options can purchase insurance against the risk of loss in a stock. While it is not an obligation to sell your concentrated stock position, it does provide an investor with the right to sell all or a portion of his or her shares at a predetermined price. If the stock price goes up beyond the put options strike price at the time of expiration then the contract expires worthless but the investor has effectively reduced the risk of a stock decline during the option holding period. Conversely, if the stock price at the time of expiration falls below the strike price, the value of the put option increases and can be sold to offset the loss in the shares of stock held. It should be noted that this strategy is highly effective over the short-term. However, over the long term, the cost of put option based hedging can be prohibitively expensive. In those cases where longer-term hedges are sought, then the investor should consider other options strategies, including option spreads, that can hedge the downside more cost effectively. Your financial advisor should be able to provide a range of alternatives for putting on longer-term hedges. If they can’t, then it may be time to find an advisor that can.

Using concentrated stock positions to increase portfolio income

Depending on the subject security, a concentrated stock position may provide an investor the opportunity to generate additional income for a portfolio as well. This is done by engaging in what is known as a covered call strategy. The investor holding a concentrated stock position can sell a covered call option with a strike price above the prevailing stock price and collect a premium (income). If the stock price remains below the contracts strike price through contract expiration, the investor holds onto his/her shares but keeps the premium collected for selling the covered call contract. If the opposite happens and the stock price moves above the call options strike price, then the investor does run the risk of having the underlying stock called away. In this scenario, the investor receives the strike price for his/her shares and gets to hold onto the premium initially collected.

Utilizing concentrated stock positions as collateral

In some cases, it may also be appropriate to use concentrated stock positions as collateral for a margin loan that can then be used to diversify your portfolio into other assets or asset classes. Of course, using a margin account has many unique risks that should be discussed with your advisor, but does provide yet another tool that can be used to reduce the risk that a large concentrated stock position may introduce to your portfolio.

Gifting shares of stock

Another strategy we see many investors use to handle the concentrated stock positions in their portfolios is gifting of stock over time. It should be mentioned however, that if not done correctly, this can trigger a tax known as a gift tax. In 2017 for example, the tax code allowed for an annual gift exclusion of $14,000 that would avoid the gift tax. It is important to remember that there is also a limit to the amount in taxable gifts that can be made over a lifetime before the gift tax kicks in. Thus, understanding whether your gifting strategy will trigger any unexpected taxes should be considered before executing this strategy. That said, it remains a viable option for many investors that do have concentrated stock positions. However, before utilizing this strategy, consult with a tax professional to understand your own tax situation and whether gifting shares of stock is appropriate in your case.

Selling shares

Sometimes simply selling shares in a concentrated stock position is the best course of action. It is a simple and straightforward strategy that will reduce overall exposure to an individual stock. However, sometimes a concentrated stock position will have a low cost basis that can create unwanted tax liabilities. As a result, working with an advisor that takes your individual tax situation into account is key. Additionally, some concentrated stock positions may not trade with high degrees of liquidity. In these cases, it is important that your advisor understand how best to unwind positions in these scenarios. This can be done through well-established trading desks or by using a disciplined approach to setting limit orders.

While these are strategies available to investors for managing concentrated stock positions, this is not a comprehensive set of the tools available. In fact, there are many more things that can be done to effectively manage the risk of holding a large portion of your wealth in a concentrated holding. For example, certain trust structures may be used, exchanging your concentrated stock position for shares in an exchange traded fund, or using a net unrealized appreciation (NUA) strategy may also be appropriate. Before selecting a strategy however, it is important to realize that managing concentrated positions is complex in nature. Therefore, it is important to work with an advisor that has strong capabilities in financial planning, employs tax professionals, and works closely with investment managers. Without coordination between these areas it could open the door to making costly mistakes when it comes to managing your concentrated stock positions.

Weekly Technical Comment

I am traveling this week and will bring fresh updates to our technical commentary next week.

If you have any questions, please feel free to email me at


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)



Planning for Retirement the R.I.T.E. Way


Some Americans spend decades of their lives working and planning to save for retirement. However, when they get close, there is very little discussion on how to plan for retirement income and distributions.

There are right ways and wrong ways to plan for retirement income, and the best way is to have a R.I.T.E.® plan (retirement income taxed efficiently). With proper financial and tax planning, you’ll be better positioned to achieve your retirement goals and to close any retirement income gap you may have to reach them.

Setting Your Retirement Withdrawal Rate

The amount you take out each month or year from your portfolio (whether it be an amount or percentage) is known as your withdrawal rate. Planning and knowing an appropriate starting withdrawal rate is a key point for analysis when creating your retirement plan. Your goal and decisions should consider the balance of taking too much and possibly running out of money vs. not taking enough and failing to enjoy your earlier active retirement years. Knowing and targeting your appropriate withdrawal rate is very important early on in retirement, as it will most likely have the largest impact on how long your savings last.

The most often quoted rule of thumb states that you can withdraw 4% annually from a balanced portfolio of stocks and bonds. Many studies show that this can provide inflation-adjusted income for up to 30 years without running out of money. In my readings, many contend that you should budget withdrawing somewhere between 3% and 5% depending on life expectancy, tax issues and market performance. However, these rules were based on historical data and are not guaranteed. There’s no perfect rule of thumb that works for everyone in every situation. (For related reading, see: Will a Systematic Withdrawal Plan Work for You?)

In order to determine your safe withdrawal rate, you need to formalize your overall financial planning goals that include your retirement, investment and estate plans. In creating your formal plan, you are able to identify:

  1. All your sources (sometimes called “buckets”) of retirement income: IRAs, 401(k)s, pensions, Social Security, deferred compensation, and other assets.
  2. Your cash needs or retirement budget to help you determine the current and future withdrawals that you will need to supplement your expected and guaranteed income sources (i.e. pensions or Social Security).
  3. Tax issues and opportunities that may need to be addressed, especially for those in higher tax brackets or if retiring younger where you would be subject to distribution penalties. (For related reading, see: Avoiding IRS Penalties on Your IRA Assets.)
  4. Tax-efficiency in your overall portfolio allocation and tax placement by reviewing all of your accounts and the underlying holdings to make sure that, where possible, tax inefficient investments are held inside pre-tax (retirement) accounts while more tax efficient investments are held in after-tax accounts.
  5. Your needed or required distributions (such as RMDs).
  6. Your family and/or charitable goals.
  7. How much risk you want and/or need to take in terms of your portfolio allocation and ongoing investment strategy. To do this effectively, you should stress-test your plan and know your hurdle rate (the minimum return you need to reach your retirement distribution goals). (For more from this author, see: Retirement Planning: What’s Your Hurdle Rate?)

Proper planning will help you know what you can and should be able to distribute as a withdrawal rate from your retirement portfolio now and into the future.

Which Bucket Should You Drawdown First?

If you have been wise, you will have assets in multiple accounts that are taxable, tax-deferred, and tax-free. So how do you plan where to take money from first when you start retirement? The answer is…it depends.

If you are single and don’t have a goal of leaving a large estate to your beneficiaries or charities, many say you should start by withdrawing money from taxable accounts first, then tax-deferred accounts, and only then from your tax-free accounts. By waiting on taking money from your pre-tax and tax-free accounts, you’ll defer taxes as long as possible while keeping keep more of your retirement dollars working for you. (For related reading, see: Not All Retirement Accounts Should Be Tax-Deferred.)

If you are married or have family goals, it gets more complicated. You will need to coordinate your retirement and estate plans. For example, if you have rapidly appreciating assets and/or highly concentrated stock positions with a low tax basis, it may be beneficial to withdraw from tax-deferred accounts first (especially in low tax years) as these accounts will not receive a step-up in basisat your death. You also should consider the benefits of a rollover of your retirement plans.

Know How to Better Optimize Your Plan and Be Tax Smart

In addition, you can really turbo-charge your retirement plan by identifying appropriate strategies and by being tax smart (the “tax efficiently” part of the R.I.T.E.® plan). This can be done by planning for and knowing your:

  1. Options to maximize the value of your Social Security benefits – especially if you are married
  2. Pension plan distribution options and determining how to best choose options in light of your plan and goals
  3. 401(k) plan rollover options – especially if you have employer stock that could benefit from net unrealized appreciation (NUA) in a rollover/distribution and if you have after-tax dollars
  4. Expected tax brackets to better utilize retirement years where you would be in a lower tax bracket. When this is known, you can utilize various retirement rollover and Roth IRA conversion strategies that may be very beneficial while avoiding typical rollover mistakes.

Bottom Line

You have spent decades saving for retirement. Given that investment of time and money, as you approach or enter retirement you should take the time to review your available alternatives and opportunities to meet your financial planning goals and objectives. This will help you make the best decisions for you and your family.


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.


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