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STA Weekly Report – What You Should Know About Tariffs and Potential Trade War

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INSIDE THIS EDITION:
What You Should Know About Tariffs and Potential Trade War
Weekly Technical Comment
IRS Finally Says Back Door Roths Are OK
401k Plan Manager

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  1. An escalated and full-scale trade war will hurt the global economy. After decades of globalization, global trade – the sum of exports and imports of goods and services – has made up more than 60% of global GDP.
  2. The global supply chain is so integrated that global trade it has become essential for the success of many businesses. The Boeing 787 “Dreamliner” is a classic example of a horizontal supply chain, with various components manufactured in the UK, France, Sweden, Japan, Canada, China and elsewhere before being assembled in the United States.

  1. There will be no winners in a trade war and plenty of collateral damage to countries not directly involved. For example, Asia’s interconnected supply chain will shift the cost of a trade war from China to suppliers in neighboring countries. Should China move to cut their imports of parts, which are further manufactured for export, by 10%, the GDP of countries like Taiwan, Malaysia, and Korea could drop by 1%-2%. While this change seems inconsequential at first glance, it would be a meaningful drag on the region’s economy.

  1. The effect of tariffs on the $20 trillion U.S. economy remain highly uncertain at this point. According to Moody’s analytics, announced tariffs to date of 25% on $50 billion of goods would reduce U.S. GDP growth by 0.1% next year. If the administration were to proceed with all proposed tariffs, including a 10% tariff on $400 billion in Chinese goods — and China retaliates in kind, the damage to U.S. GDP will rise to 0.5%. In an extreme scenario, where the U.S. put a 25% tariff on Chinese imports, and China responded in kind, the hit would rise to 1.3%. However, these are merely estimates. It remains unclear how a trade war would develop and much less clear how aggressive the countries involved might become.

Source: Moody’s analytics

  1. The trade dispute has more implications than simply closing the trade gap.

President Trump’s proposed tariffs on $50 billion of imports will fall mostly on Chinese aerospace products, information technology, auto parts and medical instruments, aiming at many of the industries highlighted in the “Made in China 2025” plan. This plan, produced by the Chinese government, identified 10 industries expected to be part of a so-called “fourth industrial revolution”, in which rapid technological innovation is expected to fundamentally transform services and existing professions. China views these industries as crucial to its future development, as the country shifts from labor-intensive industries to higher-tech manufacturing, under the pressure surging labor costs and rapidly aging population. The U.S. on the other hand views this strategy as an emerging competitive threat in industries where it still has an advantage. The threat is perceived to be even greater if Chinese companies in advanced manufacturing industries receive state sponsored investment and subsidies.

  1. Retaliation from China is strategic. China’s counter tariffs will have the greatest impact on U.S. states and counties that voted President Trump into office. For example, industries such as soybean manufacturers in the Great Plains, auto manufacturers in the upper Midwest and oil-producing regions in the Dakotas or Texas will be among the most affected.

Source: Moody’s analytics; Dave Leip’s Atlas of U.S. Presidential Elections; U.S. Census Bureau

  1. A Trade war is not a zero-sum game, but is a lose-lose for the US and China. As a result, we expect each party will act with caution. However, recent developments make us believe the probability of escalation of a trade war has increased. Because the root cause of US-China trade tension is bigger than simply the trade deficit, we don’t expect the trade conflict will be resolved quickly. Instead, we believe the trade dispute will be a persistent source of geopolitical risk and driver of market volatility for some time to come.
  2. Given the importance of global trade and supply chain integration, a full-scale escalation of a trade war would be detrimental to the world economy and financial markets. Economic models are unable to accurately forecast the secondary effects of reduced corporate confidence and the effects on business investment. Therefore, a trade war is a meaningful tail risk. On the other side, market selloffs driven by trade-war headlines and more negative sentiment could create opportunities for long-term disciplined investors who know where to look for value.

  

 

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China Shares and Currency Started Dropping in Mid-June

Chinese markets started dropping sharply in the middle of June. The red line in the chart below plots the Deutsche X-trackers CSI 300 A-Shares ETF (ASHR), while the green line plots the WisdomTree Chinese Yuan ETF (CYB). The red circle shows Chinese mainland stocks starting to drop in the middle of June before falling to the lowest level in a year. The green line shows the Chinese currency turning down at the same time before falling to the lowest level this year. That was the result of a June 15 announcement of U.S. tariffs of $34 billion on Chinese imports to take effect on July 6. China vowed to retaliate the same day. That June tumble in Chinese assets accelerated a decline in emerging market stocks and currencies that had been going on for most of the year. That’s also when base metals started to tumble.

Base Metals Also Plunged in Mid-June

The middle line in the next chart shows the Invesco Base Metals Fund (DBB) (which includes aluminum, copper, and zinc) also plunging in the middle of June (see circle). That coincided with the plunge in Chinese markets. The top box shows that agricultural markets started falling at the same time. That suggests that the sharp drop in both commodity groups was the direct result of the June 15 tariff announcements between the U.S. and China and resulting weakness in Chinese markets. The lower box shows that precious metals also fell during June, but were already being pushed lower during the second quarter by the rising dollar. It appears that precious metals were more negatively impacted by the rising dollar, while base metals (and agricultural commodities) were more negatively impacted by the falling yuan and mainland stocks.

  

Weekly Snapshot of Global Asset Class Performance

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)

 

 

IRS Finally Says Back-Door Roths Are OK

STA Wealth participates in the Ed Slott Elite IRA Advisor Program.  As part of that access, we get up to date information on all updates related to market and regulatory changes.  We just got word that the IRS has now formally accepted the “Back-Door Roth IRA” as an effective strategy.

The “backdoor” Roth method — which involves contributing to a traditional IRA and then converting to a Roth IRA — is allowed under the law.

  – Donald Kieffer Jr., tax law specialist (employee plans rulings and agreements), IRS Tax-Exempt and Government Entities Division, said July 10 on a Tax Talk Today webcast, reported by Tax Notes.

Yes, it’s official. The long-running debate on whether a back-door Roth is legal is over. It’s legal.

Actually, it was over when the Congressional Conference Report for the Tax Cuts and Jobs Act said four times that the so called “back-door Roth” was fine by them. Here is one of those statements:

Congressional Conference Report on the law:

“Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.”

Remember that the IRS is there to interpret the tax law as written by Congress. This was a gray area before only because it was not spelled out that the transaction was legal. That led some (not me!) to say the IRS would call this a step-transaction and thus it would be illegal. Well, now that Congress spoke back in December 2017, the IRS has officially approved the back-door Roth. They won’t challenge it, so it’s full steam ahead for those who qualify.

It turns out that IRS just didn’t like the words “back-door” or “workaround” when it comes to tax law. Those words are red flags for IRS.

“I think the IRS’s only caution would be whenever we see words like ‘back door’ or ‘workaround’ or other step transactions that are putatively enabling a way to get around limits — especially statutory contribution limits — you generally find the IRS is not happy and prepared to challenge those,” Kieffer said. “But in this one that we’re talking about, it’s allowed under the law.”

Back-Door Roth IRA Basics
To review, the reason the back-door Roth evolved was because of the income limits for making a contribution to a Roth IRA. Since there are no income limits on Roth conversions or on contributions to traditional IRAs, the strategy was to first contribute to a traditional non-deductible IRA and then convert those funds to a Roth IRA, bypassing the Roth IRA contribution limits. The funds actually go into the Roth as a Roth conversion, not as a Roth contribution.

Also, not everyone qualifies for the back-door Roth. You still have to be eligible to make a contribution to a traditional IRA, which is the first step in the back-door Roth process. Qualifying for a traditional IRA contribution means having earned income (except for a non-working spouse if filing a joint return with a spouse having the earned income) and not being over age 70½, since traditional IRA contributions cannot be made for the year one turns age 70½ or later years. In addition, keep in mind that the pro-rata rule applies, which means that part or all of the back-door Roth conversion might be taxable if there are other traditional IRA funds, including SEP and SIMPLE IRA funds. The once-per-year 60-day IRA rollover rule does not apply to Roth IRA conversions.

For more on Back-Door Roth IRAs, check out Ed Slott’s Definitive Guide to Back Door Roth IRAs.

Ed Slott, CPA, is a recognized retirement tax expert and author of many retirement focused books. For more information on Ed Slott, Ed Slott’s 2-Day IRA Workshop and Ed Slott’s Elite IRA Advisor Group, please visit www.IRAhelp.comMr. Slott will be a keynote speaker at Financial Advisor’s Inside Retirement conference in Las Vegas on September 27.

 

 

 



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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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