Of Multiple Tops

The S&P 500 has been flirting with a quadruple top recently.  By that I mean the index has flirted with a level of resistance that it has had trouble breaking through since the middle of last September for the 4th time.  Recently the index broke through that barrier but then promptly sold off and it's firmly back below that horizontal green resistance line running near the top of the chart above.  {You can double-click on the chart to make it larger.}  Stocks have hit trouble the last three times this has happened going back to last September.  The two failed attempts last fall set the stage for our large end of the year decline in 2018.  Failure at the end of April led to May's over 6% decline.  

The investment community is of two minds right now.  On the one side, triple tops are rare and quadruple tops even rarer.  Theory holds that each time you test these important levels resistance or support the weaker they become.   At some point under this thinking stocks should rip higher.  Investors who believe this would argue that we could potentially see a substantial move given the time we've spent in the current trading range.  The market has spent nearly 18 months locked in its current range, even longer if you mark the bottom of this current trading range to last winter's decline.  By that thinking, if or when we break out odds would favor a more sustained move.

The other side of that coin is more negative.  While we broke to new highs the other day, we also promptly sold off.  Stocks had about an 8.5% move off of their May lows and we're now over bought.  The fundamental backdrop is a bit dicey right now and at these levels stocks aren't necessarily cheap. Also history has shown in this consolidation that failed rally's have led to negative consequences.  I believe traders in this camp would argue that markets should at a minimum retest the levels we saw at the end of May and that would point towards further upside.

So there's the two extreme views right now.  The environment is somewhat negative on the Street and frankly the Wall Street crowd is more interested in the 4th of July holiday break right now than what's going on with stocks. Still we could get positive news out of this weekends G-20 meeting between President's Xi and Trump on the trade war front and maybe the Federal Reserve will lower interest rates in July so there is the potential there for an upside surprise.  I also think there might be a third scenario and that's for stocks to essentially do nothing.  Maybe we sell off a bit and then find some level of equilibrium where stocks in essence just float around for a big part of the summer.  That would be similar to what happened in 2017 when The SPY traded for two months in about an 8 point range and last summer when from mid-June on stocks moved in about a 12 point range.  That would also be in keeping with my theory of seasonality which discusses the late summer early autumn period on being traditionally one of the worst for stocks.

For us, we'll monitor the situation and let our indicators be our guide.

Chart is from Tradingview.com although the annotations are mine.

Back Monday.

*Long ETFs related to the S&P 500 in client accounts, although positions can change at any time   We reserve the right to change any of these investments without notice on this blog or via any other form of verbal, written or electronic communication.

Tax Efficiency: 4 Strategies To Consider

By Christopher R. English, President of Lumen Capital Management, LLC

Back in April, we discussed charitable giving under the new tax code.  I want to revisit the topic of taxes again this month. Again, I’ve turned to the good folks over at Indigo Marketing to help me summarize some basic strategies that may help us all lighten our tax burden next April. Through intentional planning, you may be able to mitigate the toll taxes take on your financial plan, minimizing your tax burden and maximizing the money you keep for yourself. Here, in general, are four ways you may be able to increase your tax efficiency.

1. Use Tax-Favored Investment Strategies

Tax benefits are available to investors who select specific investment strategies. Tax-favored investing is especially beneficial for professionals who are highly compensated. For tax-exempt alternatives, consider municipal bonds and Roth IRAs, and for tax-deferred options, pre-tax qualified plan investing is ideal. Your pre-tax contributions to qualified retirement plans can reduce your adjusted gross income, saving you on taxes now rather than in retirement. The most common employer-provided qualified plans are 401(k) and 403(b) plans. Everyone’s financial situation is unique, so the type of accounts that are most beneficial for you will depend on your circumstances.

Now let’s get into the details of these types of accounts to see how much they could decrease your tax burden. If you have a 401(k), you can defer up to $19,000 of your annual earned income on a pre-tax or after-tax basis. Participants over the age of 50 can also take advantage of the catch-up provision and contribute an additional $6,000.

If you are a business owner, you can lower your total taxable income even further. Solo 401(k)s and SEP IRAs are the two primary qualified plan types available. With a SEP IRA, you can contribute up to 25% of your compensation or up to $56,000. For solo 401(k)s, the annual plan contribution is the same as the traditional 401(k) plan ($19,000 for the 2019 tax year, or $25,000 for those over the age of 50). The company can also contribute a profit-sharing contribution of 25% of your income up to a maximum of $56,000.

2. Deduct Eligible Charitable Contributions

Annual gifts to qualified charitable organizations may be deemed an eligible itemized deduction. Under the new tax law, fewer taxpayers will itemize deductions due to the doubling of the standard deduction. The Tax Policy Center estimated that only 16 million people would claim an itemized deduction for charitable giving in 2018, down from 37 million. (1) Regardless, charitable giving is still a useful tax-minimization strategy. If you decide this is a viable route for you to go, you will need to note each gift on Schedule A of your 1040. If your yearly cash gifts exceed $500, you must also complete IRS Form 8323, which must be attached to your completed return. If you received benefits as a result of your charitable donation, only the amount over the benefit you received can be deducted.

You can also gift non-cash property and investment donations, which can be deducted at their fair market value. If you donate clothing or other household items, consider using available online value calculators to determine the total amount of your contribution, saving these records in the event of a tax audit. Records for all donations must be maintained, including bank records, payroll deduction notices, charitable donation receipts from the qualified organization, or phone records for text message donations.

You may also consider using a donor-advised fund to combine all charitable contributions in a year and then distribute the funds to various charities over several years. With this strategy, you may be able to itemize deductions in one year and take the standard deduction in the following years so you can achieve a tax benefit that you may not have received otherwise.

3. Invest In A College Savings Plan

Now, more than ever, may be an ideal time to invest in a 529 plan. This type of educational savings plan is a qualified tuition plan created so that families can receive tax benefits for saving toward qualified higher-education expenses. After-tax money is invested in a 529 plan, where it grows tax-free. When the money is later taken out for qualified expenses, there are no federal taxes due. Over 30 states also offer a deduction or tax credit for contributions to a 529 plan. (2)

And to increase the value 529 plans could add to your financial plan, as of January 1, 2018, 529 plans are no longer just for college. Up to $10,000 a year can be used for elementary and high school costs at public or private institutions. This provides a great opportunity for wealthier families who prefer to send their children to private schools.

Previously, the only tax-advantaged way to save for private primary and secondary school costs was through a Coverdell Education Savings Account. However, income limitations and a $2,000 annual contribution limit made them impractical or impossible for many families to use for K-12 expenses.

4. Consider A Roth Conversion

When it comes to your retirement, IRAs are one of the most widely used investment vehicles. IRAs are retirement accounts that are separate from your employment, which tends to simplify things considerably. Your IRA contributions can be invested in just about anything but life insurance and collectibles, so there aren’t as many restrictions as 401(k) plans, which limit you to a preselected group of investment choices.

Unlike the tax-deferred traditional IRA, a Roth IRA allows you to pay all taxes up front (your contributions are made with after-tax dollars). The perk is that you receive tax-free withdrawals in retirement after the age of 59½. When you decide to withdraw the money, you don’t have to pay taxes on any of the growth.

Another significant difference is that there are no required minimum distributions (RMDs). You can leave your money in the account to grow forever, instead of being required to start taking withdrawals (and stop contributions) at age 70½ as you would with a traditional IRA account. This allows you to use a Roth IRA as an estate planning tool to provide tax-free income for grandchildren and future generations.

The one caveat to a Roth IRA is that to qualify, you must fall in specific income categories. In 2019, singles making over $137,000 cannot contribute to a Roth, and the amount they can contribute begins phasing out after $122,000 of earnings. The phase-out period for married filing jointly is $193,000-$202,999. (3)

However, anyone can convert a traditional IRA into a Roth through a “backdoor conversion.” There are multiple reasons to consider a Roth conversion. For one, there are no income limitations when you convert. If you are not eligible for a Roth initially, you can pay the taxes to convert your traditional IRA to a Roth and still reap the benefits. Secondly, you can have all the benefits of a regular Roth IRA, such as no RMDs.

Roth IRAs are not necessarily for everybody.  Not everybody wants to pay the taxes upfront.  But they can be an important tool and the right fit for the right person.  Please talk to me for some basic information on Roths, as well as your accountant to see if a conversion makes sense for you.

Getting Ahead With Tax Planning

Tax planning could potentially save you thousands, tens of thousands, and in some cases millions of dollars in taxes paid. Tax planning is incredibly beneficial, but taxes can also be complicated, so don’t go it alone. The IRS tax code is 72,536 pages long and filled with various opportunities and strategies for optimal tax efficiency. The key is understanding how each possible opportunity works and how it fits into your strategy and long-term goals. Professionals must implement these strategies in accordance with the law and on a foundation of honesty.

If you have questions about any of these tax strategies I encourage you to reach out to me. Call my office at 312.953.8825 or email me at lumencapital@hotmail.com.

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 312.953.8825 or emailing him at lumencapital@hotmail.com.

---

(1) https://www.taxpolicycenter.org/model-estimates/impact-itemized-deductions-tax-cuts-and-jobs-act-jan-2018/t18-0009-impact-tax

(2) http://www.savingforcollege.com/articles/coming-soon-big-changes-to-529-plans

(3) https://www.rothira.com/roth-ira-rules

Saying Goodbye to Quarter 2

This is the last week of the 2nd quarter and traditionally when the summer season begins on Wall Street.  Between now and Labor Day the investment class will be more worried about where they will be spending their weekends.  The upper echelons of this group will only emerge from their favorite watering holes to either finish up a big deal or to help steer the ship in the event of an unlooked for crisis.  The investment class cares more about lowering their handicaps or where best to fish or eat during the next 60 days than they care about stocks.  Trading slows down over the summer and markets take on a more sleepy feel unless something unexpected washes over the transom.  

As well we'll soon be bidding the first six months of 2019 adieu.  Markets are set to open slightly higher and based on past history one should not be surprised if the next 10 days are generally positive for stocks.  Institutional money managers have a strong incentive to bid assets higher at the end of each quarter {fees and performance} and there's usually strong money flows at the beginning of a month.  Next week should be quiet in the markets as trading will be shortened by the 4th of July holiday.  Markets will only be open a half day on Wednesday and the "B-team" will be on most trading desks on Friday.   

Recently I discussed past historical patterns of seasonal weakness.  If we see anything like  the historical patterns that have come to be associated with this then under that theory stocks should peak in this current move higher somewhere in mid-July.  From there than traditionally it's been rough sledding for stocks until sometime in the fall.  Of course there is no law that says this pattern will take place this year.  It is entirely possible we'll see something different.  I point this out for readers of this blog to be aware of how this has worked in the past so as not to be surprised if it shows up sometime this summer.  

TV and print pundits will note the many cross currents pushing and prodding stocks right now. There's Iran, there's the trade war with China, immigration, the beginning of the 2020 presidential cycle just to name a few issues.  Also depending who you listen to the economy is doing great or others proclaim we're beginning to slow down and a recession is possible.  There are always cross currents in markets.  The important thing for most investors is to keep focused on the long term and their own unique investment plans.  Stocks will rise and fall.  We've chronicled time and time again that stocks typically experience at least one correction between 7-15% every year.  We've already had one of those this spring.  As I noted to you in my May letter "Seven Trends That Make Me Feel Optimistic About the Markets," there are simply too many longer term positives out there for me not to think there is a higher probability of stocks advancing over these next few years than not.   

Pay attention to these longer term trends, especially in times of heightened volatility as that will give us opportunities to add to positions we like.  In the meantime remember that Wall Street for the most part will be calling a time out until after Labor Day.

Goodbye 2nd quarter and welcome to summer!

Publishing schedule.  Wednesday, Friday this week.  Tuesday, Friday next week.

Mutual Fund Fees

Morningstar each year does a trend study on mutual fund fees.  Here are some of their findings with a comment from me after each.

-The amount investors paid to own funds hit a record low in 2018: The asset-weighted average expense ratio for U.S. open-end mutual funds and exchange-traded funds fell to 0.48%, down from 0.51% in 2017. We estimate that investors saved roughly $5.5 billion in fund expenses last year due to this 6% fee decline, marking the second-largest year-over-year percentage decline since we began tracking asset-weighted average fees in 2000. 

{Of course fees are declining.  Mutual funds have to compete against ETFs where funds of major indices may charge fees of between 3-12 basis points.  Those ETF fees have been going down as well.  Still nearly 40 basis points difference in costs and many of these funds don't outperform the indices.}

-Funds with lower fees are experiencing greater asset flows Morningstar’s 2018 Active/Passive Barometer found that, historically, fees are one of the best indicators of future relative performance, as lower-cost funds generally have greater odds of surviving and outperforming their more-expensive peers. 

{When you can't compete on value you need to compete on price.}

-Evolving advice model.  The move toward fee-based financial advice has spurred the demand for lower-cost funds like ETFs.

{When advisors are paid for advice and expertise and not motivated by commissions for a living it becomes harder for mutual funds with all their inherent disadvantages to attract assets from the RIA community.}

It's hard for me to see how the mutual fund industry is ever going to be able to compete with ETFs.  They are unlikely to go away anytime soon but they are well beyond their prime as a concept and I believe are likely going to continue to hemorrhage assets in the coming years.  Maybe funds in the big mutual fund families will make it or funds that have a niche but the small and the weak are going to go the way of the dinosaurs.

Link:  Morningstar Fund-Fee Study:  "The Key Factors Helping Drive Fund Fees Lower."

Back Tuesday.

Why Stocks Go Up & Down.

Imbedded in the link to the infographic I posted last week on market corrections from Visual Capitalist and via Fisher Investments is another that does a spectacular job on explaining market volatility.  Volatility is how we speak of the day to day movement in stock prices but for the most part investors relate to volatility in terms of market declines.  Presumably they're not to worried about price movements when stocks go higher.  The article is too long to place in here so go read the graphic "Volatility 101:  An Introduction to Market Volatility".   

Back Friday.

Is This Trump's Worldview?

This is an interesting viewpoint from the Longview Twitter feed.  Whether you love or hate President Trump this does seem to largely reflect his philosophy on how to drive economic growth.  Economists can debate whether this will work and globalists will hate it, but it does seem to reflect the environment we're in.  We need to understand this as we think about how these policies might impact stocks.

I will be posting Tuesday and Friday next week.

On Market Corrections

Go over to Visual Capitalist and take a look at their Infographic "The Anatomy of a Market Correction".  It's a pretty cool presentation on what happens when stocks decline.....And stocks do decline.  The average volatility in markets is now somewhere between 12-15%.  That means at some point stocks will experience a decline from their highs between 12-15%.  Many investors often don't remember this when sifting through December statements because most run of the mill corrections usually take place in the middle months of the year.  In that regard 2018 was an outlier as stocks corrected significantly in the 4th quarter.  This year markets have corrected from their peak about 6-8%.  That still left major market indices with returns in 2019 that would be above their long term average returns if the year ended May 31 instead of December 31.  Here's some interesting facts about market corrections from the article via Fisher Investments.

The average market correction looks something like this:

• Frequency:
  On average, there is one market correction that occurs each year
• Length:
  The average correction lasts for 71.6 days
• Depth:
  The average correction involves a 15.6% decline
• Impact:
  A correction often results in increases in uncertainty, volatility, and media alarmism.

In the current bull market, there have already been eight corrections. The most noteworthy of these went from May 21, 2015 until February 11, 2016 and resulted in a -18.9% fall in stock prices.

Corrections are inevitable.  Best to accept them as part of the price you pay for longer term hopefully superior market returns.  Most corrections don't morph into full fledged bear markets.  You usually need an exogenous shock or a financial crisis for that to occur.  Whether we're still in the midst of a correction or it's already peaked only time will tell.  But so far there's no indication that the two ingredients necessary for a gut wrenching bear market akin to 2007-2009 are in place.  

Valuation {06.07.19}

I decided I'd update our valuation analysis given the declines we've seen in stocks in May

The S&P 500 closed yesterday at 2,843.49  which is an advance of about 13.84% for the year, not including dividends.  However this represents approximately a 2.2% decline from when we last reviewed these numbers on April 17, 2019.  Below is our current valuation analysis.  We are are now using a 168.00  earnings estimate for year end 2019.     We are currently using a mid-point $173.00  for a rolling estimate out  to the end of Q2, 2020.    We also use a simple color code to give you some reference for these numbers.  Green will indicate that the valuation on the index on a strictly historical basis has become more attractive from the last time we did this review.  Red will indicate the opposite.  Black means unchanged.

Our Midpoint S&P 500 Earnings Estimate of $168 {Year End 2019}

Current PE:                       16.93% {PE has decreased from previous review of 17.20%}
Earnings Yield:                   5.91% {up from previous review of 5.819%}
Dividend Yield:                  1.84% {Yield basically unchanged}

Current Expected Price Cone of Probability {COP}:   2,500-3,000 for 2019.  2,700-3,250 for 2019. 

Rolling Four Quarter Estimate for the S&P 500, Our Midpoint Estimate $173.00:

Current PE:                     16.43% 

Earnings Yield:                 6.08% 
Dividend Yield:                1.92.% {Estimated}

The current yield on the 10-year US Treasury is 2.121%.  That is a decrease from our last update when the 10-year US Treasury was yielding 2.59%.  

The Cone of Probability {COP} is our current assessment of the trading range within which we think stocks have the potential to trade during the described time period.  It is a probabilistic assessment based on a many factors.  Some of these inputs are: Earnings estimates, also are those estimates rising or falling, dividend yield, earnings yield and the current yield on the US 10-year treasury.  This is not an exhaustive list of all of the variables that are used in creating the cone.  The Cone of Probability is used solely for analytical purposes.  It will fluctuate with market conditions and changes to the data inputs.  Index prices can and have traded outside of the range of the cone.  The data supplied when we discuss the cone is for informational use only.  There should be no expectation that this price range will be accurate and there are no guarantees that this information is correct.

*Long ETFs related to the S&P 500 in client accounts, although positions can change at any time    We reserve the right to change these investments without notice on this blog or via any other form of verbal, written or electronic communication.

Back early next week.  We will likely next update our valuation review in late July or early August. 

Chart Talk {06.05.19}

I'm posting a chart today on what I believe is a higher probability scenario of where I think we might be headed in the coming months.  I am basing this scenario largely on past experience and my theory of seasonality.  Under that theory I've noted in the past that the late summer months into the fall are the often the most dangerous period for stocks.  That's not all that much different than other studies on market seasonality that have been done which shows that the six month period beginning around May 1st is a period of weakness for stocks.  But what I've noted in the past is that stocks often suffer a drawdown in the first part of my cycle but then in the early part of the summer have a snap back rally.  That rally in this typical pattern meets resistance somewhere around highs set earlier in the year and often stalls out somewhere in mid-July.  Then after a few weeks of back and forth action markets begin a decline that often tends to worsen into the fall.  Stocks tend to find their equilibrium sometime in mid-September to early October which often sets us up for a nice end of the year rally.  If that pattern would hold this year then you could see the following sequence unfold which I've tried to lay out in the chart above.  The points I want to make are numbered and I'll explain what those numbers mean below.

1.  Old highs on the S&P 500.  What this chart doesn't show is that the green line running through the April high {which I've circled} is now structurally significant as it is also a double top high.  That is it is also near the highs we first reached in January 2018.  That means this now represents a significant area of resistance for stocks. A major break out from this area would be considered significant and probabilities would then suggest higher prices in the future.  Likewise a market that once again gets close to this resistance but then pulls back would at a minimum suggest a higher probability of more indecision in stocks or a pullback.

2.  A level of support that probability suggests stocks could find support if we see another down leg in prices at some point.

3.  Approximate line of advance probability suggests we could see over the next month to six weeks if my theory of seasonality is working this year.

4.  Approximate price area probability suggests where we might see any rally stall out during this period.  Please note that this is just a guess and based on past patterns.  We could trade higher or lower than where I've indicated on this chart.

5.  Shaded area in yellow represents the range we could expect to see from a market decline assuming my theory and the pattern holds into summer.  Again this is just a guess.  Markets could trend higher or lower than what I've indicated.

There you have it.  Please note that this is just one scenario that could take place.  There are many others out there.  I'm not saying this is going to happen and I'm certainly not saying you should trade off this pattern if you're not a client of mine since I don't know anything about your investment focus or particular risk reward patterns.  I'm putting this out so that clients and friends of my firm understand how this conforms to my seasonality theories.  Anybody else who trades on this is on their own.

Chart is from Tradingview.com although the annotations are mine.

Back Friday.

*Long ETFs related to the S&P 500 in client accounts, although positions can change at any time   We reserve the right to change any of these investments without notice on this blog or via any other form of verbal, written or electronic communication.

Post & Comments {06.03.19}

This is a new feature I've been toying around with where I respond with a brief comment to something I've either seen in the news or on line.  My comments highlighted.

The market is going to have a correction.  Well the market has now been in correction mode for over a month.  We're currently down about 6% from the highs made at the beginning of May.  Keep in mind though that we are up a bit over 17% since the Christmas Eve bottom.  We were never going  to go higher in a straight line.  The latest news is just today's reasoning for us to sell off.  If it hadn't been China and tariffs it would have likely been something else.  

We are going to have a recession.  Of course anything is possible but current data isn't supportive of that assumption.  The more likely scenario is slower growth in the next two quarters followed by a resumption as the year progresses.

China is winning the trade war.  Nobody will win the trade war.  The current tariffs are a bargaining chip as each side tries to position themselves for the best deal possible.  I still think ultimately there will be a deal because it will be in both sides interest to get something done.  However, I am less confident of a deal happening soon than I was three months ago.

Back Wednesday.