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QE & Adventures in a Fed-Driven Market: 2020 Market Recap and 2021 Outlook

QE & Adventures in a Fed-Driven Market: 2020 Market Recap and 2021 Outlook

Technically, the record-breaking bull market that started in 2009 ended in 2020. I say “technically” because the sell-off was so short-lived that it almost didn’t feel like a true bear market, and the rebound was so sharp that it didn’t feel like a proper recovery. As we continue to emerge from the Q1 shock, our new bull market sure feels a lot like the continuation of the previous decade-long uptrend, with the same drivers (low rates, central bank intervention) and the same dominant sectors (with big tech leading the way). 

Last year’s events left many investors with a feeling of unease at the disconnect between the economy and the market. Many were already skeptical about valuations prior to COVID. When a brief collapse was immediately followed by a moon-shot to unthinkable new highs, investor skepticism rose along with it. This is perhaps the most common point of concern for our clients: how can weak economies, with falling demand and rising unemployment, justify higher equity prices? When faced with this question, I’ve often tried to draw our clients’ attention to the prodigious scale of the monetary measures being implemented, and to the fact that the link between markets and the economy isn’t always as direct and linear as many investors expect, as we will discuss later. 

One way or another, it’s largely been about the Federal Reserve and their international counterparts (ECB, BOJ…), and while 2020 will probably be remembered as the year when everything changed, as far as markets are concerned, we seem to be trapped in the same powerful dynamics that were in place a year ago, and which have become even more deeply entrenched as a result of the pandemic.

Fun With Trillions

At the beginning of 2020, many observers would have described global monetary policy as extremely loose, historically so. Part of the bearish narrative was that central banks had run out of ammunition: with both ECB and Federal Reserve balance sheets hovering around all-time highs, and interest rates near zero, surely there wasn’t much left for central banks to do. 

As it turns out, they were just warming up. 

Keeping up with monetary policy and high-flying government finance requires a rare skill: the ability to make sense of large — very large — numbers. Can anyone really wrap their minds around numbers like 665,900,000,000,000 — or 666.9 trillion — the approximate size of the Bank of Japan’s balance sheet in Yen? 

Central bankers and politicians seem to deal only in rounded trillions nowadays: the first COVID relief bill was 2 trillion dollars, the ECB expanded its Quantitative Easing (QE) program in June by 1.3 trillion Euros, and so on…and with every new trillion-dollar headline, the world of big finance grows increasingly disconnected from reality, almost like it exists in its own parallel universe. 

Trying to relate the idea of trillions of dollars to something tangible would look something like this: if you had 1 million dollars in a compact stack of 1,000 dollar bills, the stack would be approximately 4 inches in height. A million is a lot of money by any standard, yet it’s small enough to carry in a handbag. To get to a billion dollars, the stack of 1,000 dollar bills would have to grow to about 358 feet, or about 50 feet higher than the Statue of Liberty. To get to a trillion, the stack would need to grow to a length of approximately 67.9 miles. (1)

Central bankers don’t need to worry about the logistics involved in printing and shipping 70-mile long stacks of bills, they save themselves the hassle by creating currencies in electronic form, but the impact on markets of their various trillion-dollar endeavors are just as real. 

To understand why 2020 was truly the year of “Fun with Trillions”, consider the following chart:

The main global central banks have added nearly 8 trillion dollars to their combined balance sheet in 2020 alone. Source: Atlantic Council global QE tracker

The Federal Reserve added 3.2 trillion dollars to its balance sheet in 2020 alone, more than it did in the entire 2009 to 2019 period. Source: fred.stlouisfed.org

Over 20% of the U.S. money supply (measured a Money of Zero Maturity) was created in 2020 alone. Source: fred.stlouisfed.org

So what does this all mean? Therein lies the issue for investors — we can observe trillions of dollars being (digitally) printed and hear about it on the news, but what does it mean for markets? How does that relate to the size of our 401k’s? Or Apple’s share price? What would today’s markets look like if QE had never existed?

One team of analysts at Société Générale did attempt to answer this thorny question. (2) Sophie Huynh and Charles De Boissezon, of the bank’s equity research group, used a regression analysis to estimate the impact of QE on treasury yield. They estimate it at about 180 basis points cumulatively since 2009 (in other words, without QE the 10-year yield would be close to 3%). They then used a dividend discount valuation model and the bank’s proprietary model for equity risk premiums (the excess return of equities of bonds) to derive a hypothetical valuation of stocks without QE. 

Their results are rather striking.

As shown above, the impact on stocks’ prices has been dramatic according to their model and even more pronounced in the NASDAQ than the S&P 500.

Overall, the bank’s model estimates that 44% of today’s S&P 500’s price level can be attributed to QE. In the tech-heavy NASDAQ, the percentage rises to 57%. The pace of change has not been linear, and 2020 saw a massive spike in the percentage of price level explained by QE.

We’ll never know how accurate this model truly is, but I believe it captures one fundamental truth about current market conditions, which is simply that QE changes everything. 

With the 10-year yield over 3%, and the S&P 500 at 2000, markets would certainly not be as exciting as they are today, but some might say that they would be a more honest reflection of the economy.

The eternal bullishness of a stagnant economy 

Whatever QE’s impact on the market might have been, it’s unclear whether it has benefited the economy in any meaningful, lasting ways. The pace of U.S. economic growth has generally been around 2% for nearly a decade until 2020.

Early forecasts indicate a decline in U.S. GDP of around 3.5% in 2020, though it’s expected to rebound in 2021. Meanwhile, corporate earnings have barely grown in the last few years, even as markets soared to all-time highs.

This environment of stagnant economies and earnings growth has prompted many to speculate that markets have risen too far, too fast, and these concerns are valid. After all, QE or not, one would expect economic realities to eventually catch up with markets. All else equal, slowing earnings growth should result in lower stock prices. With that being said, we must also keep in mind that the market and the economy are two distinct entities.

In a recent research piece, Vincent Deluard (StoneX’s head of macro research) makes a simple yet counter-intuitive point which I think helps capture a lot of today’s market dynamics. His view can be summarized as follows: in an environment of secular stagnation, where discount rates and growth decline, stock prices will soar. To understand his point, it helps to review some very basic concepts of equity valuation. 

Stocks are ultimately just claims on a future stream of cash flow, a dividend for example, or whatever might correspond to the liquidation value of a company. Any stream of future cash flow is valued by dividing the periodic cash flow by a discount rate, which accounts for the time value of money, and for risk. For example, a hypothetical annual payment of 10 dollars that lasts forever would be valued by simply dividing 10 by 5% (if we assumed a 5% discount rate): 10 / 0.05 = 200, so this perpetual cash flow of $10/year is worth $200 dollars today.

Equity valuation works in a very similar way, but the discount factor is slightly more elaborate. One example of a basic stock valuation model is the Gordon Growth Model, which works with the formula on the left.

This is conceptually very similar to our perpetual annuity example. The discount rate “r” can be thought of as the rate of return that investors require for the stock, the constant cost of equity capital. Because company earnings grow over time, “g” is added to account for growth, and reduces the discount rate, causing the value of the ratio to increase (the stock price to rise).

Going back to our example, imagine a company (let’s call it Stagnant Inc.) that pays a $10 annual dividend per share. Stagnant Inc’s share price could be valued as follows using the Gordon Growth Model:

10 / (0.10 – 0.5) = $200

In the above example, 0.10, or 10% is the “r”, the discount rate, the return investors expect, and 0.05 is the 5% growth of the company’s dividend. If we assume that Stagnant Inc.’s growth rate declines by 10% a year going forward, and that the expected rate of return “r” also declines by the same 10%, the stocks price over a 50 year period would like this:

In 50 years, Stagnant Inc.’s stock price soared from $200 to over $34,000, a gain of over 11% a year, all happening despite a steady decline in earnings growth. This is what Vincent Deluard refers to as “the crazy math of secular stagnation.” (3)

Source: Vincent Deluard, StoneX research, www.marketintel.stonex.com

As shown above, lower capital costs (discount rate) can justify higher valuations even in the face of dwindling earnings growth. As both growth and discount rates trend towards zero, prices rise to infinity.

This is perhaps what many investors have missed when constantly expecting markets to fall back to earth: while there truly is a disconnect between the economy and markets, there may also exist a causal link between economic weakness and higher stock prices, a self-reinforcing trend of perverse incentives where slow growth fuels market uptrend, where bad news for the economy can quite literally become good news for stocks, and markets may have been riding this stagnation boom for many years now. 

I would add that QE and central bank interventions are factors that will tend to affect expected returns over time. In markets, the cost of equity capital is mainly a function of interest rates, volatility, and risk premia. By keeping interest rates low and dampening volatility, central banks’ activity can really be thought of as one giant exercise in reducing expected returns. When the Federal Reserve announced that it would start buying high yield bond ETFs, the prices of these bonds quickly jumped. There is nothing irrational about this investor behavior. If a high yield bond had a yield of 6% prior to the Federal Reserve’s decision to step in, once the Fed enters the fray, investors were happy to accept a lower yield, maybe 5%, simply because they knew the Fed would step in to support prices as needed. Equities work the same way. In a world where any weakness or volatility is met with the immediate expansion of the Fed’s balance sheet and trillions in government intervention, you would expect equity investors to feel more comfortable and adjust their risk appetite. For example, a stock that an investor would have normally considered too risky to buy (perhaps a high-octane IPO), can suddenly become a very justifiable acquisition once the Fed’s de-facto pledge to support markets is factored in. Coincidentally, more IPOs have doubled in price in 2020 than any year since the tech bubble. (4)

This reasoning can be pushed even further to explain some of the current sector dynamics: in a world of constantly falling cost of capital, equity valuation becomes disproportionately affected by cash flow duration. To draw a parallel from the bond world, if we knew that rates were going to consistently decline, we would naturally look to buy the longest-dated bonds (maybe a 20+ year treasury). Likewise, if the equity cost of capital is constantly falling, winning the equity valuation race becomes a game of who can extend cash flow duration the furthest into the future. 

This may at least partially explain why today’s dominant stocks are to be found in the tech world. As highlighted in StoneX’s report, U.S. tech giants, with their low payout ratios, low book values, and future-proof product lines, can be thought of as the equity equivalent of a very long-dated bond and will benefit the most from the falling cost of capital. The SocGen report referenced earlier also highlighted that the tech sector’s outsized benefit from QE for similar reasons. 

In the game of ever-increasing cash flow duration, current earnings and profitability are secondary to future cash flows. Any company with a semblance of growth enters the race to a near zero-value denominator and is disproportionately favored by investors. Similarly to how aggressive bond traders might look to increase the convexity of their books (buy bonds with the highest duration sensitivity to changes in yield), equity traders could be chasing stocks with the greatest pace of price appreciation for a given decline in capital cost, endlessly bidding up speculative growers in the tech world, at the expense of value and yield. 

These ideas would certainly be consistent with what we witness almost daily in today’s market, which appears to be obsessed not just with innovation, but with all manners of futuristic buzzwords. In today’s world, computing is not enough, you need quantum computing, automation is not enough, you need AI, databases are not enough, you need blockchain, trucks are not enough, we demand cybertrucks.

But of all the tech-obsessed endeavors, my favorite is probably space exploration. When it comes to creating the longest cash flow duration imaginable, I can’t think of anything better than spending the next few decades burning through trillions of dollars building spaceships, all in the hope of one day dominating the intergalactic travel market. So it is perhaps no surprise that just about every billionaire CEO seems in love with the idea: Elon Musk has SpaceX, Richard Branson has Virgin Galactic, Jeff Bezos has Blue Origin. In a day and age when life on earth seemingly requires a constant supply of face masks, antiseptic wipes, and experimental vaccines, perhaps the time has come for us to propel ourselves into outer space in search of less green pastures. After all, life in one of Elon Musk’s planned human colonies on Mars can’t be all that much different from being locked down in a Berlin suburb. (5)

WHEN APPLES AREN’T APPLES

In his book “The Systems Bible” John Gall introduces a concept he calls “operational fallacy”, which describes instances where systems do not do what they say they do. The best way to explain operational fallacy is to think of a simple term like “fresh apples.” Fresh apples can evoke the thought of strolling through your grandmother’s garden on a late summer day, and picking ripe apples right off the tree, perhaps to make a delicious pie later that day. But “fresh apples” could also be an item you grab from the shelf of a suburban supermarket while quickly pushing your cart down the produce aisle one evening after work. In both examples, the term “fresh apples” is technically correct, yet the two products and experiences are nothing alike. What most people really want is grandma’s apple experience, but that’s exactly what the system cannot provide.

2020’s pandemic and the ongoing economic struggles of the last decades have prompted leaders around the world to implement a variety of support measures to stimulate the economy. Those same decision-makers would no doubt congratulate themselves on what they perceive to have been decisive and successful steps that secured the economy, fostered growth, and protected the integrity of markets through difficult times. Yet the results produced by this complex system of incentives hardly match what most would look for in a prosperous economy. The economic equivalent of grandma’s apple would probably involve a combination of plentiful well-paying local jobs, healthy government finances, and growth. Instead, the current economic landscape delivered stagnant growth, gig-economy, and soaring deficits. 

Perhaps these support measures are more likely to produce supermarket apples: the mechanism through which quantitative easing (by far the largest component of all stimulus attempts) benefits the economy is still unclear, and one could argue that QE is in fact counterproductive. Instead of promoting growth, easy money and low rates may instead lead to misallocation of capital, leading to weaker economies and fueling the vicious cycle of stagnation. 

What these measures did achieve was a spectacular rally in stock price, and this may be because QE is more akin to a form of price control than an economic stimulus. Historically, price control has involved various attempts to reduce the price of goods to curb inflationary forces, but we have no need for that type of price control now. In today’s upside-down, hyper-financialized world, we’re instead attempting to generate growth and inflation by controlling the price of risk, the cost of financial capital. Global markets are supposed to be way too large to be controlled by anyone, but trillions of dollars have a way of coercing even the strongest forces of their will. 

Attempts at price control generally have a terrible historical track record, and while I spent a lot of time justifying the market‘s continued rise in my comments, it’s important to note that the same market dynamics can work just as efficiently in the opposite direction to produce sharp sell-offs and volatility.  This may be the greatest challenge our decision-makers will face: how to navigate our way out of the current QE-fueled trap, and back to healthier market dynamics?  

Eventually, market forces always prevail against attempts to control them. Everything has a price, and even if the current trends remain in place for the foreseeable future, sooner or later, the law of unforeseen consequences will cause distortions created in one part of the market to re-emerge somewhere else, the challenge of 2021 and beyond may be to figure out where that might be.

Syl Michelin, CFA®

SOURCES

(1) https://vimeo.com/98550343

(2) https://wholesale.banking.societegenerale.com/en/solutions-services/markets/cross-asset-research/

(3) www.marketintel.stonex.com

(4) https://www.yahoo.com/now/more-ip-os-have-doubled-in-their-debuts-this-year-than-any-year-since-the-tech-bubble-140607697.html

(5) https://www.space.com/37200-read-elon-musk-spacex-mars-colony-plan.html

2021 INVESTMENT & OUTLOOK GUIDE

This piece was part of Walkner Condon’s 2020 Review & 2021 Investment Outlook Guide, a comprehensive interactive PDF covering a wide range of subjects and trends, including the S&P 500, electric cars, and more. To read the full guide, please click the button below.

What is Going on with GameStop?

What is Going on with GameStop?

GameStop, Reddit, Elon Musk, and stocks (or the meme-friendly term ‘stonks’) — all four of those spheres have collided to bring about the latest internet trend, which is just as fascinating as it is perplexing and, for some, alarming.

The GameStop saga also involves hedge funds, including a $2.75 billion bailout of Melvin Capital by a pair of billionaire investors, Steve Cohen and Ken Griffin, and a motley crew of retail investors, some of whom are members of the r/wallstreetbets subreddit, one of a multitude of discussion forums on Reddit.     

All of that build up leads us to the question on everyone’s lips: “What is going on with GameStop?

That was the question addressed on the latest episode of Walkner Condon’s podcast, Gimme Some Truth, as Clint, Keith and Stan try to make some sense of this bizarre sequence of events. They describe what “shorting” a stock is, what a “short squeeze” is, and why the concerted efforts of Redditors have put a short squeeze on GameStop and driven up the price an incredible amount in a short time.

From there, they look back at the (not so) recent history of the market and discuss this in the context of the dot com boom of the late 90s—along with analyzing some of the more nefarious activities of traders and speculators in that era. Finally, the three explain why this trade should likely be avoided (both for financial and legal reasons) and explain the SEC’s reputation and history on cracking down on some of these sorts of market manipulations. 

For those looking for more discourse on this subject, here’s a breakdown of events from CNN, which dives further into some of the more nuanced stock concepts involved. There’s also this New York Times story from 2001, a story referenced on the podcast, about a New Jersey teenager who became the first minor ever to face proceedings for stock market fraud. 

Investment Guide: Reviewing 2020 and Financial Outlook for 2021

Investment Guide: Reviewing 2020 and Financial Outlook for 2021

INVESTMENT GUIDE & OUTLOOK FOR 2021

With all of our advisors contributing content, this is Walkner Condon Financial Advisors’ first-ever comprehensive investment guide. The guide covers a wide-range of topics – from electric cars to the S&P 500 to sustainable investing, as well as some trends we see in the markets in 2021. The COVID-19 pandemic has affected nearly all aspects of our lives, and that thematic undercurrent runs throughout the course of this guide, both in the review of 2020 and the year that lies ahead.

Will My Taxes Change Under a Biden Presidency?

Will My Taxes Change Under a Biden Presidency?

If you’ve tuned into any of the Presidential debates, seen ads on TV, or scrolled through your  social media, you have probably heard some discussion around taxes. Joe Biden has stated that he plans to increase taxes on households with more than $400,000 in income and that if your household income is less than that you will not see an increase in taxes.

Let’s define “income”. In simplistic terms, your gross income is your salary. From a tax perspective, there are many derivations from gross income. By following a US tax return you would find that there are other sources of income (e.g. dividends, capital gains, IRA distributions, etc.) that will be included in your Total Income. Your Total Income is reduced by “above-the-line” deductions to arrive at your Adjusted Gross Income (AGI). From there, you subtract the “below-the-line” deductions, usually either the standard deduction or an itemized deduction, to arrive at Taxable Income. Why did I go through this mini-exercise of how to arrive at Taxable Income? Because Taxable Income, not Total Income, is what is subject to the tax bracket tables. So when Joe Biden refers to a household making more than $400,000 in income, he is likely referring to Taxable Income. For example, for those that have a household salary of exactly $400,000 would not be included in the group that Biden refers to, because ultimately their Taxable Income would be something less than $400,000. 

I don’t have a statistic to back this up, but I would guess that most Americans would lump all taxes into one giant tax bucket that ultimately goes to the federal government. Of course taxes are more complicated than that. For one, there are federal taxes, state taxes, and local taxes. Most of this blog will be focused on federal taxes. Furthermore, most of the time devoted to discussing taxes is around the federal individual income tax, because it affects a vast majority of people in the United States. I’ll also briefly touch on transfer taxes (estate and gift), retirement plan deductions, and corporate tax.

What proposed tax increases or changes have we heard about? 

Increase the top tax bracket. One of the easiest pieces of Biden’s tax plan to understand is raising the highest marginal income tax bracket from 37% to 39.6%. The 39.6% tax bracket wouldn’t be all that new; it is actually a reversion back to the highest marginal tax bracket in 2017, the last tax year before the Tax Cut and Jobs Act (TCJA) provisions took effect.

Increase capital gains tax. Biden also proposes an increase in the capital gains tax. A capital gain is realized when an asset (e.g. a stock) is sold at a price higher than the price that the asset was purchased. Long-term capital gains (the asset is held greater than one year) can be much more favorable than ordinary income tax rates. The proposal is to increase the highest long-term capital gain rate from 23.8% (technically it is 20% capital gains tax plus 3.8% net investment income tax = 23.8%) to the highest proposed marginal tax rate of 39.6%, for those “making more than $1 million”. It goes without saying that those making more than $1 million are making a pretty good amount of money, but it isn’t entirely clear if that refers to individuals or those married filing joint tax returns.

Flat credit for retirement plan contributions. This next point isn’t necessarily an increase in a tax rate, but it instead limits the amount taxpayers could deduct for their retirement plan contributions. Ultimately that could mean a higher tax bill for high-income earners. Retirement plans such as a 401(k) allow a worker to defer income taxes on the amount that they contribute to the retirement plan, within the IRS-allowed limits. IRAs have similar tax-deductible features. The way it currently stands, if someone in the 37% tax bracket were to contribute $10,000 to a tax-deferred retirement plan, they would realize $3,700 of savings for the tax year. Meanwhile, someone in the 22% tax bracket would only realize $2,200 of savings if they were to contribute $10,000 to the same tax-deferred retirement plan. Biden would like to equalize the tax savings by imposing a flat contribution credit. The Biden website doesn’t specifically propose what that flat credit would be, but some analysts expect a 26% tax credit. High income earners might want to reconsider their tax-deferred vs. Roth strategy if this were to go into effect. 

Elimination of stepped-up basis. One proposal that would greatly change how people approach estate and legacy planning is getting rid of the step-up in basis of inherited assets. In most cases, someone that has inherited assets from a decedent will receive a step-up in basis. For example, if someone bought $10,000 of stock (their basis is $10,000) and it appreciated to $100,000 and sold it while they were alive, they would realize a $90,000 gain. The $90,000 gain would be taxed at capital gains rates. If that same person died before selling the stock and passed it to a beneficiary, the beneficiary receives a “step-up” basis of the fair market value of the stock at the date of the decedent’s death (let’s assume it was $100,000). Therefore, if the beneficiary sold the stock right away for $100,000 they would not realize taxable gain ($100,000 market value – $100,000 stepped-up basis = $0 taxable gain). If Biden’s proposal were to come to fruition, the beneficiary would not receive the stepped-up basis and instead have to pay tax on the $90,000 gain. The Biden proposal could end up taxing unrealized gain obtained from an inheritance, meaning that the beneficiary could get taxed without even selling the assets. There would be some planning opportunities in this case, including strategically selling the assets during their lifetime, gifting the assets, or utilizing life insurance to help beneficiaries with a potential tax bill. 

Elimination of the QBI deduction. The Qualified Business Income (QBI) deduction will be eliminated for those that make over $400,000 in income. I will touch more on this later but this could essentially increase the tax bracket for high income, self-employed business owners from 29.6% (with QBI) to 39.6% (Biden’s proposed highest marginal tax bracket).

Increase the corporate tax rate. The TCJA reduced the corporate tax rate from a top rate of 35% to a flat corporate rate of 21%. If reelected, Trump intends to keep it that way. This is one of the provisions from TCJA that doesn’t sunset; it is permanent (unless the tax code is changed again). Biden proposes to increase the 21% tax rate to 28%.

What (most likely) would need to happen for Biden’s tax plan to go into effect?

First, win the Presidential election. Then the Democrats would likely have to sweep Congress by maintaining a majority in the House of Representatives and win a majority of the seats in the Senate.

What about the TCJA sunsetting?
Let’s not forget that most of the existing provisions that affect individuals and families from the Tax Cut and Jobs Act in 2017 are set to sunset on December 31, 2025. That means the following will go back to pre-TCJA code, unless the tax code is updated between now and then:

Individual/household tax rates
For the most part, households saw a reduction in their marginal tax rate under TCJA. However, those that have taxable income between $400,000 – $424,950 (married filing jointly) actually saw an increase in their top marginal tax bracket from 33% to 35%. After TCJA sunsets, the highest marginal tax bracket will return to 39.6% from 37%.

Standard deductions
The effect of the increased standard deduction was that more households utilized the standard deduction instead of itemizing their deductions. The standard deduction jumped from $12,700 to $24,000 (married filing jointly, and indexed over time) from tax year 2017 to tax year 2018, due to the legislation. When TCJA sunsets, the standard deduction will again be lowered and it might be more attractive for households to begin itemizing their deductions again. 

Itemized deduction limits
TCJA limited the extent to which once could utilize an itemized deduction. TCJA introduced limits on the following relatively common itemized deductions: State & Local Taxes (SALT) deduction, mortgage interest deduction, medical expenses deduction, tax preparation and investment expense deductions. Limiting the aforementioned deductions further encouraged more households to utilize the standard deduction.

Pass-through entity deductions
Up to 20% of Qualified Business Income (QBI) can be deducted from income received from flow-through entities. Business owners that are part of an S-Corporation, a partnership, sole proprietorship, or another pass-through entity that have utilized the 20% QBI deduction will have to resort back to tax planning strategies that they have used for several decades before TCJA was enacted.

Gift/estate/generation-skipping tax exclusion
The estate tax exclusion increased significantly under TCJA, which in 2020 is $11,580,000 per person. Most people will not be subject to pay estate taxes out of pocket due to this large exclusion. If the exclusion reverts back to 2017 levels (pre-TCJA), the exclusion amount would be $5,490,000 per person. Many more households would be subject to estate tax in the scenario of the reduced estate tax exclusion. 

In summary, there is a lot that is up in the air when it comes to how the tax code may change. It might not change much at all if President Trump gets re-elected or if Joe Biden gets elected and there is a split Congress. It could change significantly if Joe Biden gets elected along with a Democratic sweep in the House and Senate. The way it currently stands is that many provisions will at least sunset at the end of tax year 2025. My main goal of this blog is to provide some education and insight rather than try to convince you that one tax code is better than another. We would love to be a resource for you and will continue to keep our clients informed as new developments arise.

Mitch DeWitt, MBA, CFP®

COVID-19 and the Real Estate Market

COVID-19 and the Real Estate Market

The Coronavirus is affecting our lives in many different ways. Eating in with carryout and delivery instead of reservations at restaurants and bars, Zoom meetings and teleconferences instead of office meetings, waves instead of handshakes and hugs; the world is a different place than it was two months ago.

More of the Same….and Then It Wasn’t

The beginning of 2020 looked quite similar to the start of the last few years in the housing market. Then, as we know, everything changed in March with COVID-19. We are now left with many more questions than answers. Mortgage rates have fallen to even lower levels as the Fed is desperately trying to help the economy. This, in turn, created a glut of refinancing applications for mortgage lenders. However, the negative economic impact of COVID-19 is far reaching, creating tremendous liquidity problems within the banking system. It is difficult to close on a mortgage refinance when the money to pay off the existing mortgage is in limbo, or lock a rate on a mortgage application when the lender has no idea how long it will take to get to a closing table. Delinquencies on existing mortgages will certainly increase as homeowners deal with an uncertain job market, leading one of the country’s largest mortgage lenders, JPMorgan Chase, to change their lending guidelines in recent weeks.

Uncertainty Abounds 

The economy is in a very different place as well. Strong earnings reports and record low employment numbers have been replaced with the utmost of uncertainty. Almost every aspect of the economy is dealing with some level of ambiguity, with the housing market taking center stage. The housing market over the past decade has been, for the most part, quite strong. This has been fostered by low interest rates, ample cash liquidity, and friendly lending guidelines. This, however, has led to the issue of low inventory and excess demand for the last few years. While this has been positive for house prices and mortgage applications, it has created an imbalance. Builders are trying to take up the slack by fast-tracking new home construction, and anyone remotely interested in selling a home has been enticed with the idea of completing offers to purchase within days, instead weeks or months.

Housing Recession Imminent?

With all of this said, it would be easy to assume that the housing market is headed for a recession of its own, but I wouldn’t be so quick to come to that conclusion. This is one of the more resilient components of the overall economy. People need to buy and sell houses every day, regardless of what is happening in the rest of the economy. We will likely have a low interest rate environment for the foreseeable future, which should keep the market somewhat stimulated. 

What To Do?

What should you do if you are in the process of a refinance or house sale/purchase? First things first…don’t panic! Nothing good will come with trying to force the process to go faster or demanding that things happen. The task at hand will require more patience and understanding than in previous years. The refinancing timeline has shifted to a couple of months versus a couple of weeks. Locking rates will almost certainly become more difficult than it was before, and underwriting guidelines are changing. My recommendation would be to work with a mortgage lender who is in touch with the current protocol and can guide you through the process. You need to be working with a lender who provides specific advice and has a strategy for operating in this environment. This, in my opinion, isn’t the time for the internet lender who is offering a teaser rate of slightly below the market rate. This is a time for trusted advisors. If you need a recommendation, please let us know and we would be happy to provide you with the contact information of different lenders.

Nate Condon 

Investment Committee Meeting Recap: Responding to Market Conditions

Investment Committee Meeting Recap: Responding to Market Conditions

With work from home, school from home, and everything else from home, routines have been disrupted for many of our clients. Fortunately for us at Walkner Condon, our preparations for the need to work offsite (detailed in Clint’s post from March) have meant that our processes have largely remained unchanged. Last week, we held an investment committee meeting (via Zoom of course, with the proper password protections!), which is a key part of our ongoing investment management process. As part of our commitment to transparency, we wanted to share some of the thoughts we discussed during the meeting.

Portfolio Structure

In general, we have maintained our overall portfolio structures as they accord with our client’s risk profiles– that is to say, we have not made overall shifts from the percentage of assets allocated to bonds or stocks. However, in our discussion we also acknowledged that maintaining our long-term strategic outlook of correlating overall allocation to a clients’ financial plan is a tactical decision, especially in light of the market volatility.   

Bonds for Balance

That said, we have not left our clients portfolios untouched, and we discussed the various markets where we see opportunities and how to position our bond and stock portfolios. For instance, our overall strategy views our bond allocation as a defensive position in our clients portfolio. Consequently, our most recent rebalances look to make our bond positions more defensive in light of the ongoing uncertainty in the market. Moreover, we discussed how one of the advantages of smart-beta and active management in the bond portfolio is that it can lead to less risk exposure in negative environments like the present. Such a defensive position may help clients in the short term and also allow us to rebalance effectively into stock positions. 

Stocks for Growth

Regarding those stock positions, we discussed where we see longer term opportunities in the markets given the longer-term fallouts from the coronavirus. While we aren’t making any predictions about the shape of or the timeline of the U.S. recovery, we do continue to think that rebalancing towards a core of U.S. equities will be a solid investment for the long-term. In that context, we’ve also noted that in the previous ten years we have experienced marked outperformance from U.S. equities. The continuing strength of the U.S. dollar (which will lower the cost of their exports), coupled with a strong response to the global pandemic could mean that Asian stocks are also particularly well-positioned for long-term growth.

As we continue to discuss the strategies surrounding our clients and our portfolios, the key refrain of this discussion and others is that we need to continue to align our portfolios with our clients long-term needs and let the portfolio construction continue to be governed by our clients’ financial plans and goals.

The Walkner Condon Team

Authored by Keith Poniewaz