Taking Measure: December 2017

We are now entering the quiet season where we reflect and take measure of the past twelve months. For better or worse, the investment year is basically over. Unless a cataclysmic event occurs soon after this letter is put to rest, we will find that the markets have been mostly kind to us in 2017. As usual, there are concerns going into the new year and probability suggests that we will likely see a return of volatility in the future. But those are next year’s concerns. For a few weeks, these worries will be gently pushed over the horizon as thoughts bring many of us to friends, family and holiday cheer. It is wise, then, to spend a few moments to pause and reflect. As such, if this letter is less about investing than others, you will perhaps forgive my musings.

I have been working with clients in the investment business since August of 1987, not too long before the great crash of that year. I have seen both good and bad markets, periods where investors were giddy with excitement and others where they were mired in despair. Yet, I don’t remember a time like now when such an undercurrent of anxiety lurked beneath what has, for the most part, been generally healthy markets.

You can call me an optimist, but lost in the negative news of the year are some wondrous discoveries and events. We are closer today to driverless cars, drone delivery, and reusable rockets. We have witnessed significant advances in nanotechnology and robotics. We have seen breakthrough medical initiatives that will grow organs and regenerate tissues, a reduction of deaths globally from diseases such as malaria, as well as new treatments for HIV/AIDS and Alzheimer's. Additionally, there have been announcements of new drugs to fight diseases like Multiple Sclerosis and certain forms of cancer. Because of these and other advances, one of the major health problems of our time is obesity, not starvation.

Inventor and industrialist Elon Musk talks about colonies on Mars and boring holes for a hyperloop. Others speak of mining asteroids for profit. There is an estimate out there (although its authors admit it's far-fetched nature) that the asteroid belt has potentially $700 quintillion in untapped valuable minerals. If you’re having trouble imagining that amount, it’s a 7 with eighteen zeros behind it. What might not be so hard to believe is an estimate by the same author that the $339 billion worldwide space market today could grow to $2.7 trillion by 2045.  All of these advances signal jobs and should also lead to economic growth.

Speaking of economic growth, the U.S. GDP will likely average around 3% this year and should be close to that in 2018. Unemployment is the lowest it’s been in years and many Americans’ net worth is now the highest it’s been since before the start of the Great Recession. If the economy continues to grow, then stock prices have the potential of moving upward over the next few years. So don't be blinded by the rhetoric out of Washington or from the press. Follow the money; this year it's voted for stocks.

I believe much of our negativity is still a hangover from last year’s election. Many are uncomfortable with our President. Others are turned off by the endless pattern of partisanship we seem to see at all levels of government. Also, decent people cannot help but be disgusted by the actions of some of our politicians and the higher echelons of the entertainment and business industries. It is right to feel this way but I believe it is wrong to attribute this, as some do, to the American people at large. Most are good decent folk, people who have families and concerns similar to you. I also don't believe Americans are as divided as those on the extreme right and left would have you believe. Unfortunately, though, they're usually the ones on the media soapbox. We're a country of over 330 million people, living in multiple regions and coming from many different backgrounds. There will always be someone or some event that fits into the expectancy bias of the most vocal voices on both the right and the left. For the most part, though, the rest of us have opinions and beliefs that generally fall into the center.  

In this era of divisiveness and rancor, it’s hard to believe that we’ve been here before. But while watching the remarkable Ken Burns series on the Vietnam war, I was reminded how bad things were then as well. In many ways, our current tenor mirrors that period. We somehow managed to work our way through all the chaos back then and I’d like to hope we’ll be able to do so again.

The Wall Street Journal runs a duo set of editorials around Thanksgiving written by their long-time columnist Vermont C. Royster (now deceased). The first, “The Desolate Wilderness” is an accounting attributed to William Bradford of the Pilgrims leaving Delfshaven in Holland on their journey to the New World. Its companion piece “And the Fair Land” is partly the inspiration for this letter because the content could have been plucked out of today’s headlines. In it, Royster mentions how “his countrymen cannot forget the savage face of war. Too often they have been asked to fight in strange and distant places, for no clear purpose they could see and for no accomplishment they can measure.” One cannot help but think of our young people manning walls in places many of us would be hard-pressed to find on a map. Or when he mentions “the good and pleasant bounty that surrounds [us] can be destroyed in an instant by a single bomb,” it takes very little imagination to see the back and forth nuclear threats between our President and the leader of North Korea instead of the Cold War era rulers of the Soviet Union.

Mirroring some of our current domestic issues the editorial also asks, “How can they turn from melancholy when at home they see young arrayed against old, black against white, neighbor against neighbor, so that they stand in peril of social discord. Or not despair when they see that the cities and countryside are in need of repair, yet find themselves threatened by scarcities of the resources that sustain their way of life. Or when, in the face of these challenges, they turn for leadership to men in high places—only to find those men as frail as any others.”

It is important to note that Royster wrote this column in 1961 before Vietnam became a national crisis, before the political assassinations and social chaos of the 1960s, long before our current culture wars and long before Americans began to seriously question the integrity of those they elected to political office. Richard Nixon had not yet resigned and Bill Clinton had not yet been impeached. Presidents Trump, Bill Clinton, and George Bush were teenagers and Barack Obama was a baby. My guess is that Royster could have expressed these same sentiments in 1798, 1815, 1865, 1932, 1946, 2001 or 2017 instead of 1961, and found them not off the mark.

Why, when we are beset by both internal problems and external threats as we have been many times before, do we continue to thrive as a nation? The editorial makes two key points. First, “We can all remind ourselves that the richness of this country was not born in the resources of the earth, though they be plentiful, but in the men [and I would add the women] that took its measure.” It is the resourcefulness of the American people and their inherent resolve and decency that has allowed this country to grow and prosper. We are certainly not perfect, but these measures have held us in good service all these years.

Secondly, as noted, “We can remind ourselves that for all our social discord we yet remain the longest enduring society of free men governing themselves without benefit of kings or dictators. Being so, we are the marvel and the mystery of the world, for that enduring liberty is no less a blessing than the abundance of the earth.” America has a ways to go before we finally arrive at that “more perfect Union” the Framers of our Constitution hoped to achieve. But I would like to believe that we in our own admittedly mortal ways scratch, claw, work and endeavor to make this place closer to that beacon, that “shining city on a hill”, so envisioned by our earliest immigrants. It is my wish and belief that America remains that way for those that hope to come here someday, for those of us who are already lucky enough to be here, and those yet unborn generations to come. I will always believe we can do that.

I hope my optimistic tone is not too much for many of you this holiday season. I am well aware of our nation’s problems, as was Royster in 1961. However, it is a season of hope and it is in that vein this letter is offered. We’ll get back to the usual investment analysis as winter engulfs us here in January. Until then, it is my wish that however you celebrate this season it finds you healthy and happy. Here’s also to a prosperous 2018!  Finally, as always, thank you for your continued trust and support.

Happy holidays and peace to you during this season!

About Chris

Christopher R. English is the President and founder of Lumen Capital Management, LLC-a Registered Investment Advisor regulated by the State of Illinois. A copy of our ADV Part II is available upon request. We manage portfolios for investors, developing customized portfolios that reflect a client’s unique risk/reward parameters.   We also manage a private partnership currently closed to outside investors.   Mr. English has over three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 708.488.0115 or emailing him at lumencapital@hotmail.com.

 

*You can access both “The Desolate Wilderness” and “And the Fair Land” through the footnote link above, but I have also included a reprint of “And the Fair Land” below.

And the Fair Land

“Any one whose labors take him into the far reaches of the country, as ours lately have done, is bound to mark how the years have made the land grow fruitful.

This is indeed a big country, a rich country, in a way no array of figures can measure and so in a way past belief of those who have not seen it. Even those who journey through its Northeastern complex, into the Southern lands, across the central plains and to its Western slopes can only glimpse a measure of the bounty of America.

And a traveler cannot but be struck on his journey by the thought that this country, one day, can be even greater. America, though many know it not, is one of the great underdeveloped countries of the world; what it reaches for exceeds by far what it has grasped.

So the visitor returns thankful for much of what he has seen, and, in spite of everything, an optimist about what his country might be. Yet the visitor, if he is to make an honest report, must also note the air of unease that hangs everywhere.

For the traveler, as travelers have been always, is as much questioned as questioning. And for all the abundance he sees, he finds the questions put to him ask where men may repair for succor from the troubles that beset them.

His countrymen cannot forget the savage face of war. Too often they have been asked to fight in strange and distant places, for no clear purpose they could see and for no accomplishment they can measure. Their spirits are not quieted by the thought that the good and pleasant bounty that surrounds them can be destroyed in an instant by a single bomb. Yet they find no escape, for their survival and comfort now depend on unpredictable strangers in far-off corners of the globe.

How can they turn from melancholy when at home they see young arrayed against old, black against white, neighbor against neighbor, so that they stand in peril of social discord. Or not despair when they see that the cities and countryside are in need of repair; yet find themselves threatened by scarcities of the resources that sustain their way of life. Or when, in the face of these challenges, they turn for leadership to men in high places—only to find those men as frail as any others.

So sometimes the traveler is asked whence will come their succor. What is to preserve their abundance, or even their civility? How can they pass on to their children a nation as strong and free as the one they inherited from their forefathers? How is their country to endure these cruel storms that beset it from without and from within?

Of course the stranger cannot quiet their spirits. For it is true that everywhere men turn their eyes today much of the world has a truly wild and savage hue. No man, if he be truthful, can say that the specter of war is banished. Nor can he say that when men or communities are put upon their own resources they are sure of solace; nor be sure that men of diverse kinds and diverse views can live peaceably together in a time of troubles.

But we can all remind ourselves that the richness of this country was not born in the resources of the earth, though they be plentiful, but in the men that took its measure. For that reminder is everywhere—in the cities, towns, farms, roads, factories, homes, hospitals, schools that spread everywhere over that wilderness.

We can remind ourselves that for all our social discord we yet remain the longest enduring society of free men governing themselves without benefit of kings or dictators. Being so, we are the marvel and the mystery of the world, for that enduring liberty is no less a blessing than the abundance of the earth.

And we might remind ourselves also, that if those men setting out from Delftshaven had been daunted by the troubles they saw around them, then we could not this autumn be thankful for a fair land.”

Some Time Off

I'll be taking some time between now and the New Year.  I'm fulfilling a bucket list wish of mine I've harbored since I was in college.  I'll tell you more about it when I've returned.  We'll pick up right back here early in January.  I want to wish each and every one of you the happiest holiday season and a prosperous new year!  See you in 2018.

In the words of Tiny Tim, "God bless us everyone!"

Don't Spend That Tax Money Yet {If You Live In Cook Co. Illinois}

So like I'm sure a lot of you I've been listening to the relentless back and forth on what the passage of the tax bill means for the average American and the economy.  I think only time is going to tell whether this is a great stimulative shot in the arm for the nation as the Republicans proclaim or the Christmas gift to billionaires as the Democrats shout in protest.   What this will do for stocks in the coming year is anybody's guess as well.  It seems realistic to think that some of the run-up in prices this fall have been in anticipation of the tax bill.  It's too early to speculate on what this might do next year.

I've taken a look at some of the numbers on what people might save in taxes next year.  Some of them I've received from here.  If the reductions pan out then it seems fodder for both sides to continue to scream and shout at each other.  For example and according to what I've read for a single payor, somebody earning around $32,000 a year currently pays about $2,735 in Federal taxes once all deductions etc are figured in.  Under the new plan they'll pay a currently estimated $2,178.  That's around a 20% tax cut.  An impressive statistic but on a real basis a projected savings of $557 a year or about $46.50 a month.  That doesn't seem to be quite the boost to the wallet the touters of the plan are proclaiming.

Finding examples of the actual savings for married couples filing jointly right now is a bit harder.  From what I can tell, a couple in this category making $100,000 will save anywhere from $1,200 to possibly $1,800 next year.  Again on the surface that sounds like a nice bit of change until you consider that on a money basis.  Again $100-$150 may not put a lot extra in the wallet, especially if that couple has children.

What's not in the tax bill though is a lower cap on social security taxes.  That's the 6.2% deducted from your paycheck each month.  This year you don't max out on that until you've made $127,200.  Next year you don't max out until you've made $128,700.  For those who have to worry about such things, it seems you'll pay another $93.00 in social security taxes in 2018.  What's also not in that bill is a way to lower health care costs for the average American.  I'll guess most folks will pay 4-8% more all in by the time we tally up the end of 2018.  

Then there's the special presents you get if you live in a high tax area like Cook County, Il.  I'll use where I live because I see the statistics here.  Living in states like New York or Connecticut will have similar issues but I'm not familiar with their numbers.  I know what's going on here.  The combined sales tax rate for Chicago, IL is 10.25%. This is the total of state, county and city sales tax rates. The Illinois state sales tax rate is currently 6.25%. The Cook County sales tax rate is 1.75%.  We saw an increase from 9.25% last year.  Giving us then the highest sales tax in the nation.  I'm not certain we still hold that dubious distinction.  If you own property in Cook County you will see over the course of the next two years substantial property tax increases as a result of most homes being assessed much higher than the last time the surveyors came around.  In my case, I'm looking at a likely 10-15% increase.  Those landowners in the city of Chicago were hit with a 10% increase by the city back in June.  Oh and if you live in this area you're being hit or will soon be hit by substantial increases in water rates {30% increase phased in over five years} and transportation.  None of this by-the-way does much to address the chronic underfunding of most pension systems up here or addresses the issue of the State of Illinois being broke.  The state added its own present earlier in the year by increasing the income tax rate 32% from 3.75% to 4.95%.  

Forgive me for throwing some coal in your stocking but when I take a look at the numbers it's hard for me to see from a back of the envelope calculation how the average person's going to have anything extra a year for now unless they get a raise at work.  My casual look at the numbers shows that what the "Feds" may be giving out is mostly going to be soaked up at the state and local levels, at least in these parts.  Maybe we'll delve a bit more into these numbers after the new years.  President Trump may have intended to play Santa but the locals sure seem to want to be the Grinch.  

What If?

What if stocks go down?  Yes Virginia, just as there is a Santa Claus, at some point stocks will have a decline again.  So let's just do a little "what if"  scenario and pretend that last week marked a top in the market.  Now of course I'm not saying that it did, just as I don't know if stocks will go up this week.  I'm simply saying let's pretend that if we're on the verge of a trend change what would that look like. We'll just take a look at the S&P 500's ETF symbol SPY in this analysis.  I've drawn the lines of where such a decline would likely take us above based on last week's prices and historical percentage benchmarks.  You can double-click on this chart if you want to make it bigger.

So say we have something so benign as a 5% correction.  That's the sort of thing that used to occur regularly before it seems they decided to outlaw volatility.  Based on last week's closing prices this would take us down to around the 253-255 level on the SPY, or about to where we were trading in October.  You would right now give up about six weeks of gains.  

A 10% correction would take you back to roughly the 240 level on the index or back to levels we saw early in the summer.  A 15% decline would trade around the 225 level and roughly wipe out all of 2017's gains.  Remember the historical volatility of the S&P 500 is something like 14%.  A 20% decline would roughly take you back to where we traded around last year's election.

And that's it.  It's perhaps a testimony to the power of this year's rally that from where we're currently trading it would take a pretty significant decline to erase the all the gains of the past 14 months.  Notice that right now a normal bear market, which by definition is considered to begin when stocks decline around 20% does nothing more than take last year's gains away.  At some point stocks will go down again.   I'm trying to give you some conceptual context of what it might look like the next time this happens, assuming we have something that could be classified as a normal correction in a longer-term secular bull market.

I have a lot to get completed before the end of the year and I will be gone over the Christmas holiday.  Right now I'm planning on posting here a few more times this week then I'll be shutting it down until 2018.  

We own ETFs related to the S&P 500 in client and personal accounts. Short S&P 500 in a personal account as part of a separate individual strategy. Positions can change at any time without notice on this blog or via any other form of electronic communication.

Year End Tax Planning

As I said yesterday, we're now getting a better picture of what's going to be in that new tax law that's likely to be signed by the President before the end of the year and will likely be implemented for the 2018 tax year.  Below I've listed some links for you to click that will give you some idea or suggestions of tax moves  you might be able to take advantage of between now and the end of the year.  

The problem of course is there's not going to be a lot of time between the time the bill's signed and the December 31 year end deadline for 2017 tax calculations to go and get some of these things done.  Also some of these suggestions such as tax loss harvesting, that is making sure you take capital losses in this calendar year to offset any realized gains you might have taken earlier in 2017, should be part of your tax planning every year for taxable accounts.  Below is the list.  I'd also suggest talking these over with your tax advisor before making any major changes before the year ends.

Cnbc.com: "Year End Tax Moves to Make Before Tax Reform Kicks In"

Business Insider.com: "5 last-minute tax moves to make now before Trump's tax plan goes into effect"

Forbes.com: "smart money moves to make before year end"

I think this list is a good place to start though I'm sure there's others out there you can dig up with a little effort.

Back early next week.

The New Tax Plan

While the new tax plan that's being bandied about Congress is not yet law, there's enough we now know of what's likely going to be in what's eventually passed that we can start to get a general idea of how it might impact taxpayers.  Below Business Insider does a pretty decent job I think of summarizing what the proposed tax brackets will be going forward for both single filers and married individuals filing jointly.  Below I've shown in the tax brackets as compiled by them.

First is the brackets for single filers:

Then here's what a married couple filing jointly will pay:

Notice there are no personal exemptions anymore but the standard deduction increases.  Also, as I indicated above, this isn't the final bill.  The middle-class should see a slight decrease in their tax burden but it doesn't seem to be some huge windfall and one estimate I've seen pegs it for many families at a savings of a bit over  $100 a month.  I have some thoughts on how this will impact Americans in the middle but I'm going to wait until I see a final cut of the bill to discuss what I think it all means for them.

Link:   Businessinsider.com: "How 2018 Tax Brackets Could Change Under the Trump Tax Plan in Two Charts"

Biosynthesis & Marijuana

For those of you interested in the developing marijuana industry I invite you to head review over at Visual Capitalist website this post called "Biosynthesis:  The Science That May Unlock the Medical Potential of Cannabis".  It's too long and published in a visual format that's difficult for me to post here, but that link gives you a long form visual reference on the developing sciences and processes that are being used on cannabis to potentially unlock its medical benefits.  

Now before the marijuana bugs come out in full force at me, I want you to know that I am making no investment references here.  What I'm trying to show is the developing science that's trying to extract value out of the plants.  Invest on your own and at your own risk in this industry.  I have no opinions and make no recommendations.

Back Wednesday

In The "Things Are Getting Better" Department

We like to note from time to time how things are getting better.  In that vein I saw this the other day that according to Bloomberg Americans' nest eggs have never been bigger.  Bloomberg cites data from Fidelity that shows the average 401(k) account now has a balance near $100,000 and the average IRA has an all time high balance of $103,500.   The share of American families with retirement accounts is also now over 52%.  

Now look  there's still an awful lot of folks with no retirement plans at all and Americans for the most part have woefully little saved for retirement, but this is a step in the right direction and is further evidence of the improvement we've seen in economic news these past few years.

Back early next week.

Still At Sea

USS Arizona {BB-39} departed Naval Station Pearl Harbor 0806 hours Hawaii time December 7, 1941. Sill listed at sea by the United States Navy.

As of last summer there were only five survivors left of the USS Arizona.  

On President Trump

I get asked all the time how the market can continue to trade higher in the face of what to many is an incompetent President.  Today I'm going to try and answer that.  First off let me get a few things out there.  I don't do politics on this blog.  There are plenty of other places you can go to get that sort of fix.  If I discuss anything political here it is solely in trying to get you to understand how events in the political sphere bleed over into the economic environment.  A growing economy, and the resultant growth in corporate earnings is what ultimately grows stock prices.  I also don't believe Americans are as divided as those on the extreme right and left would have you believe.  Unfortunately though, they're usually the ones with the media soapbox.  We're a country of over 330 million people, living in multiple regions and coming from many different backgrounds.  There will always be somebody or some event that fits into the expectancy bias of the most vocal voices on both the right and the left.  For the most part though, the rest of us have opinions and believes that somewhat occupy the center.  With that being said here's my take on the President.

The markets have been going up this year on an elixir that includes an improving global economy, growing employment, an attack on government regulation and the possibility of tax cuts.   Of these four things, the seeds for the first two were planted early in the Obama Administration and have begun to bloom for the past few years.  It is a measure of how badly the last economic depression stung us that it took so many years to climb out of it's depths.  President Trump can really take no credit for those even though he will.  The attempt to rollback regulation and the now real possibility of tax reform are things that are happening on his watch.  However, they also represent standard Republican beliefs on taxes and the role of government.  Tax reform in particular is largely happening on Capital Hill.  Of these four then the President can really only take credit for the rollback of certain regulations.  So what's changed?

In my opinion, what's changed for many investors is that the shackles of government are being loosed from business.  Note I said loosened and not removed.  The reaction to the Great Recession was perhaps an overreach on many businesses, particularly those like housing and the financial industry that may have played a large role in bringing it about.  I think there is now an attempt to get rid of the regulations that make no sense, while keeping the ones that have been shown to work.  I think all that plus a growing economy sends a signal that it's ok to make money again.  You won't be demonized by those in power if you do.  I think on top of all other things the markets like that.  You may not like that answer and I'm not trying to convert you if you don't care for what you just read.  I'm trying to tell you what I see.  Money goes where it's treated best and right now a large beneficiary of that is the stock market.

You of course will hear none of this from the American news media.  They hate Mr. Trump with a passion reserved previously only for Richard Nixon.  There's not one thing he has done or plans to do that receives anything but a chorus of boos from everybody out there but Fox News.  It's understandable.  They backed the wrong horse in the last election and now stand with a torn up winner's bet.  But, in doing so, they've shredded for the most part any mantle of impartiality they may at one point have held.  I say this again not to be on a soap box but as a way of trying to explain why stocks have ignored most of the negative news out of Washington.  If things continue to get better then stock prices have the potential over the next few years of moving higher as well.  That's because things will continue to get better.  I say this again without trying to preach or step on anybody's political views.   I care about any of this in the context of managing money how the political realm might impact my client's accounts.  I say don't get blinded by the rhetoric out of Washington.  Follow the money.  So far this year it's voted for stocks.

Market Returns

Here are the 2017 total returns of major asset classes through the end of November.  {You can assume that we are long the majority of the equity related classes in client and personal accounts plus a smattering of accounts own gold.}  A few things I've noted:

Foreign equity has outpaced the US this year.  The belle of the ball has to be emerging markets, up 32% so far in 2017.  However, let's also note that emerging markets haven't participated all that much so far since around Labor Day.  You won't see that here but just pull up any major emerging market ETF and you'll see what I mean.

A 60/40 portfolio is up 13.5%.  The chart above assumes you rebalance this portfolio so one would assume there would be performance drag from capital gains in taxable accounts and commissions.  

US stocks are up about 20% when using the Russell 3000.  

Gold up a bit over 10% would usually have that crowd up and yelling but its returns this year look a bit punk when compared to other asset classes.  Still 10% is not something to sneeze at.

Cash finally yields something again.

Back Wednesday.

Link:  Capital Spectator:  Major Asset Classes via AbnormalReturns.com.  

Chart Talk {12.01.17}

Two of the things that have been underpinning this market have been corporate profits and low inflation.  Two posts below we showed a chart that shows the growth of corporate profits in 2017.   The chart above shows that corporate profits as a percent of GDP are near record levels.  The negative way to read this is that from these levels, corporate percentages have nowhere to go but down over the next several years.  Probability would suggest that corporate profits being range bound somewhere between current levels and around the 10% level would be supportive of equities.

Also below see the graph that shows historical Price to Earnings levels {P/E} for inflation.  The average P/E is 17.6 based on the 2-3% inflation environment we are currently in.  Stocks right now trade on average with an 18 P/E.  That is slightly above the average rate and elevated from the lowest P/E.  Notice though that were well below that highest level of 26.7.  Again, about average on P/Es for this inflation environment is an element supportive of stocks as we start looking ahead to 2018.

Back early next week.

Link:  Disciplinedinvesting.blogspot.com, "Answering Market Questions Over Thanksgiving" via Abnormalreturns.com: /2017/11/26