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All Posts By Michael Lecours, CFP®

Buybacks Drive Stocks Higher

This  post is written by Clif Jarvis an advisor at Ohanesian / Lecours.

 

The tax cuts that went into effect this year lowered the corporate tax rate from 35% to 21%.  Of course, most corporations were not paying that, the effective rate that was actually paid was much lower. However, the new lower 21% official rate allowed corporations to lower their effective rate even further and boost earnings.  Also of great importance, it allowed for bringing overseas earnings back home for a limited time at a substantially reduced tax rate. While the goal of this  ‘bring the money home’ legislation was to increase investments in plants, equipment, and jobs (which is happening) much of the cash is going to stock buybacks.

Stock buybacks are driving the stock market higher. Corporations are buying shares in the open market creating demand and driving prices higher. Additionally, when corporations buy their own shares they ‘retire’ these shares leaving fewer shares outstanding. Each remaining outstanding share then represents a larger piece of the corporation. Therefore, when total earnings are reported, a smaller number of shares are divided into them. This increases earnings per share and further boosts share price.

Unlike paying out dividends to shareholders, buybacks do not involve immediate taxation. Dividends are taxed up to 20% while buybacks can result in meaningful capital gains in share price which will only be taxed when they are eventually sold. Buybacks can be a very positive way to reward shareholders with earnings in excess of what the underlying corporation needs to finance ongoing business plans.

So far this year, buybacks are running at a record pace.

Furthermore, and not quite as positive, several years of ultra-low interest rates have encouraged corporations to borrow money to buy back shares. This has resulted in record levels of debt carried by U.S. corporations. While stock buybacks help boost share price in the short run, this incurred debt may be problematic over the long run as more and more money is going towards interest payments. This leaves less for ongoing business needs, especially in recessionary times.

While there is no equation to forecast the effect of buy backs on future share prices, it is continues to be a very strong positive in the short run.

Keeping Tariffs in Perspective

Recently, I was asked about my thoughts on the tariffs and the impact it may have on a portfolio.  What follows is my response:

“I see this as a giant game of chicken between China and the US.  I see this causing a lot of anxiety and volatility in the market, but I’d imagine that someone is going to “blink”, a deal will be struck and no tariffs will be enacted.    There will always be some issue that is of concern that gets blown out of proportion which leads to an overreaction among investors (thanks to the 24/7 media coverage). It could be the possible government shutdown, conflicts in Ukraine, North Korea, Brexit, elections, or rate hikes.  All of these received the same kind of media attention over the last 3-4 years.

It’s hard to separate ourselves from these kinds of issues because we are so close to them. It’s currently happening around us.  It’s on the news. It’s being discussed around the water cooler.  We are seeing it translate to the performance of our accounts.  And that can be scary.

Ultimately, in working with clients, I take a longer-term view on the markets. How will we look back in five years on the impact of these tariffs if enacted?  I can’t help but believe that it would be a foggy memory for most investors, just like Brexit, the taper tantrum, and the government shutdown.  And you take it out to an extreme example, some investors are starting to forget their fears they had during the last recession because they are seeing their account values grow significantly above the pre-recession values.

So in the grand scheme of things, I don’t see the tariffs as having a material impact on your situation in the long term. “

The Psychology of the Tax Refund

The average tax refund is about $3,000. And people do one of two things with it. They either spend it or set it aside for a specific purpose. What’s the distinction between these two groups of people? It all comes down to their expectation.

If the refund was unexpected, chances are it will be spent. This group of people is subject to the Windfall Syndrome in which “found” money is spent more freely than money earned.

If the refund was expected, chances are it will be saved. I’ve heard many people refer to their tax refund as “the money they will use for vacation” or “the money used to pay off last year’s Christmas bills”. This group of people abides by a behavioral finance concept known as Mental Accounting.

The key to all of this is the expectation. It is the single most important factor in determining if the refund will be spent or saved. It just goes to show how powerful a little bit of planning can have.

The Most Unusual Tax Deduction I’ve Ever Heard

What do you do with a house you no longer want? What if it’s a house in bad shape but you love the land?

Up until recently, I would have offered two options: renovate it or knock it down and rebuild.

Turns out there is a very creative strategy. You donate the house to the local fire department, who in turn burn it down for training purposes. You, in turn, receive a sizeable charitable contribution.

It’s common enough of a strategy that the Journal of Accountancy wrote a summary piece on what to be aware of (it’s written for CPAs, so it’s really technical, but the conclusion confirms it).

Analysis of the Tax Cuts

Recently some clients attend a talk on the recent tax law changes by Eliot Bassin of Bregman & Company. I thought it was interesting enough to send the slides out to readers of the blog and newsletter as there were several important take-aways that were new to me.

See the Slides: Analysis of the Tax Cuts Jobs Act

Here are a few slides that jumped out to me:

Slide 10: A comparison of tax brackets and who pays more (Red) and who pays less (green)

Slide 24: A simple impact analysis based on different hypothetical situations

Slides 33-40: a summary of tax changes affecting CT residents

 

The Surprising Superbowl Tax Twist

The following post is written by our current intern, Calvin Nastyn. He is a student at the University of Hartford where he is studying finance. The issue that Calvin digs into is a wonderful (and comical) example of an odd implication associated with state taxation laws.

Benjamin Franklin once said in a 1789 letter that “nothing can be said to be certain except death and taxes.” We are taxed in every aspect of our life. Whether it’s going to the store to buy groceries or even working to make a living, taxes are always going to follow no matter what. With 2017 being the year of tax reform, it is without a doubt that taxes are a complex subject. Those who have filed taxes know that there are hundreds, if not, thousands of different facets and nuances that our federal, state, and local taxes mandate. Anything that has to do with money has its own little (or big) section in the tax code.
Football player Jimmy Garappolo can attest to the fact that taxes are complicated, even though they may have worked in his favor. Long story short: Jimmy Garappolo, a former Patriots quarterback, will end up earning more than Tom Brady from the Super Bowl. Because pay for the Super Bowl extends to former players who played at least 8 games during the season of the Super Bowl, Garappolo will reap earnings from the biggest game of the season in which he and the team he is currently part of is not on the field. But how will he make more than Tom Brady, arguably the best quarterback in history? Minnesota law states that any professional athlete who is a non-resident of the state must pay taxes of his earnings from the team that year multiplied by a fraction that equals (total duty days worked in Minnesota/total days worked in the season). Since Garappolo has no duty days in Minnesota, he would have an effective tax rate of 0% in Minnesota. Rather, he would just be subject to the tax in the state where he lives, which is most likely taxed at a lower rate, given that Minnesota has the 2nd highest income tax rate, following California at number 1.

The point is that there are times where taxes can sometimes work in your favor or sometimes against it. Investors, in particular, are never certain about what may happen in the markets. They can only control risk. But when its time to cash out, there can be many costly tax implications that can severely hinder gains. You can be the best investor in the world, as Tom Brady is the best quarterback. However, if you don’t know your way around taxes that come along with investing, you can end up earning less than the guy who worked a fraction of what you did.

Source

Stock Market Update

For the first time in close to two years, the stock market is spooking investors. The decline was swift, sudden and unexpected.  It caught many people completely off guard.  A lot of the headlines I read over the weekend, yesterday and this morning were written to evoke more fear.  I’ve pulled together a few good quotes and excerpts to help put recent market events in perspective:
  1. “Don’t be scared, and don’t be impulsive. Be disciplined no matter what the market environment, and keep saving and investing according to your long-term plan,”  Kristin Hooper, chief global strategist at Invesco. Source
  2. “We are reminding clients to keep this in perspective and look to be proactive not reactive to the markets at this time. It is a big emotional test of…risk tolerance; we all want the upside but remember there is downside risk and goals, risk tolerance and time frames must always lead one’s investment decisions.”  Jeff Carbone, Managing Partner of Cornerstone Wealth. Source
  3. On average, there’s been a market correction every year since 1900… Instead of living in fear of corrections, accept them as regular occurrences. Source
  4. What’s more, the abnormal smoothness of the stock market over the past couple of years set investors up for a shock whenever stocks did fall at least 5%, as they did on Monday. As I pointed out last month, in the low-volatility market we’ve seen until recently, “even slight declines are apt to set off talk of Armageddon, and you will need to focus harder than ever on long-term returns to keep short-term losses from rattling you.” Source
  5. The Dow is down -0.4% year to date.  Source
  6. And then some people are selling because they aren’t people at all, but software programs that have been programmed to sell when others are selling. Source
  7. Losses — as in the Dow falling a little more than 7% over the past two trading sessions (including its biggest point drop ever on Monday) — loom larger than corresponding gains, according to those who study behavioral economics. In other words, losing 7% of your money hurts twice as much [as the pleasure of] making 7%. So, it’s normal, it’s human nature, that you’re in panic mode. But don’t act on your panic. Or at least don’t panic sell. Source
  8. “If investors were happy with their asset allocation on Thursday, they should find stocks more attractive today. Of course, investors sometimes are asleep at the wheel and a periodic wake-up call can be useful, but prices are just back to where they were a couple weeks ago, so why panic?,” Source
  9. We’ve had 15 straight months without a monthly loss in U.S. equity markets. Source
  10. The 665-point decline in the Dow Jones Industrial Average on Friday was the largest since June 2016. However, back in 2016, the Dow declined about 5%, and Friday’s drop was 2.5%. Source
  11. And while Monday’s drop was the biggest point drop ever, it still pales in comparison to the largest daily percentage losses: On Oct. 19, 1987, the Dow fell 22.61% and on Oct. 28, 1929 the Dow fell 12.82%. By contrast, Monday’s drop was 4.6%. Source
Still looking for some more perspective?  Consider reading this article written by CNBC a few years ago.
We are closely watching the situation and will act accordingly as the events continue to unfold.

Patience is an investment strategy

This post is written by Cliff Jarvis:

“The secret to investing, is to sit and watch pitch after pitch go by and wait for the one in your sweet spot. If people are yelling, ‘swing, you bum!,’ ignore them.”

Warren Buffet (Source)

 

I remember, years ago, a client called and exclaimed: “This market is on a rocket ride, you better get on board.” At the time, the stock market was trending higher and higher with disregard for how much the price (of stocks) were in excess of their actual value. The market continued to go up until it didn’t. And, as history shows, it didn’t end well. The trend exhausted itself and, in the spring of 2000, it turned, suddenly and dramatically. In 2007, the same scenario happened again.

Recently in an article by article by Rob Arnott Vitali Kalesnik and Jim Masturzo they pointed out that when the price of stocks is extended over their traditional value measurements it “is not a useful timing signal for market turning points, but is a powerful predictor of long-term market returns” and that currently “no matter what adjustments we make, the U.S. market is expensive.”

But wait, rapidly rising markets can be a great way to make money? As we are seeing, overvaluation can continue for some time.

Per wisdom of Jeremy Grantham, a legendary value investor: “I recognize on one hand that this is one of the highest-priced markets in U.S. history. On the other hand, as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market.”
“Bracing Yourself for a Possible Near-Term Melt-Up.”

So what to do?

The pull of this rapidly rising market is too strong to ignore. The fear of missing out (FOMO) is irresistible. You’ve got to be in. You’ve got to do it. Prices may well move much higher and stay there! But know the stock market is currently no bargain. Maybe being patient and waiting to buy when prices are below values is an investment strategy.

I believe now more than ever it is important to know what you own so you can stay focused on the long-term. Stay diversified, do not over-invest, stick with quality, and wait for the ‘fat pitch’. Do not let the fear of missing out cloud your long-term investment decisions. If you are not going to try to time the market with short-term trades, do not be afraid to wait for a fair price.

The Usefulness of Market Outlooks

“Who knows” was my answer when I was recently asked about my own outlook on the markets for 2018.

Over the last few weeks, my inbox has been flooded by dozens if not a hundred market outlooks by prominent research firms, economists, and strategists.  And they are all completely different.  Some see significant stock market appreciation while others see little to no growth. Some see more growth in the US than abroad.  Others see more growth in the foreign markets than in the US.  Some see rising rates to be an issue.  Others do not.  And some even predict a negative year for the stock market. Chances are they are all wrong!

They are interesting to skim through to understand what they believe are the biggest issues to occur in 2018.  But it’s just as fascinating to see what is not included in their outlooks.  There are even some research groups that make a living by reading through old Market Outlooks and calling out all the wrong predictions.

Think back to this time last year.  Trump was just sworn into office and it seemed like everyone was waiting for some kind of market correction to occur.  But it didn’t!  Volatility is now way down.  Markets have shrugged off much of the bad news that has come out in recent months (such as North Korea).  Any market outlook that expressed these kinds of views would have been quickly dismissed if written in early 2017.

It’s a reminder to stay focused on your investment strategy.  There is a lot of noise that distracts investors and all to0 often leads them into making poor investment decisions.