Quarterly Reflections - October 2018

The universe is under no obligation to make sense to you. ~ Neil deGrasse Tyson

On the economy

It is becoming difficult to know who, or what, to believe when reading the tea leaves of the American economic future. The administration is unabashedly sunshine and rainbows when it comes to the next two-to-four years of economic growth. Much of the recent glow stems from the impressive Gross Domestic Product in the 2nd quarter. This is our most comprehensive and important scorecard so should be treated as such.

However, peel back layers on the 4.2% growth and we see some anomalies. Notice that 0.6% is attributable to a one-time rush to buy soybeans ahead of China’s 25% tariff on our largest agricultural export. Another 0.8% is directly due to the government stimuli that will have a fading effect over time. Legislation and pre-purchases of exports make up 1.4% and will not be repeated factors in the future.

(Please note that this chart was created on 7/31/2018 and GDP was subsequently revised up to 4.2%.)

Also, consider the impact of the four components used by the Bureau of Economic Administration to compile GDP.

Only 5.5 years of data is listed here but the trend has been similar for decades. Consumer spending followed by corporate and government spending has driven our growth. Undeniably we have become a more dependent country with a global trade imbalance. We have tilted in favor of a highly educated workforce at home that prefers service and intellectual property production to manufacturing work. (Revisit Q2 2018’s letter on increased college costs over last 20 years to see how higher education has affected our wallets.)

The goods we do create are highly specialized while most of the physical goods we need, or want, are more efficiently and cheaply made elsewhere. As the US has moved through this intellectual capital cycle, net exports have only shown quick up-ticks during recessionary periods. Perhaps exports will shift up in the near future but at what cost, and will the backdrop be a recession? Is there another way or must we employ high tariffs and sharp elbows in the global marketplace in order to continue economic dominance?

On the markets

There was no summer vacation this year for U.S. stock market. It was hard at work notching up gains and blowing off bad news, including the aforementioned trade clashes with China, Canada, Mexico and too many other countries to reasonably list here. Alongside the good reports of continued low interest and inflation, a tight labor market, growing retail sales, mildly growing wages and the highest consumer confidence in 18 years, the rise is not surprising. There also remains a lack of compelling investment alternatives outside of our stock markets.

Much has been made of how much the FAANG* stocks have driven, or pulled along, our markets but it has worked this way for decades. A few dominant players and sectors frequently set the tone for the rest, in good and bad times. More recently, over the last 3 and 12 months, 67% of the S&P 500 stocks have had net positive performance.

We still believe that publicly traded markets are efficient at forecasting future profit growth, which is what the recent run-up suggests. However it is not logical to assume that the U.S. can keep expanding at this clip as the rest of the world contracts. Remember that 30% of corporate revenue (based on the S&P 500 companies) comes from overseas customers. The rest of the world is not sitting so economically pretty so how long will it be before some of that spills over to our stock prices? Other variances may become more worrisome.

The Eurozone, which had seemed so stable a year ago, is struggling again and thus given up much of their recent stock gains. The culprits are known. Tariffs are weakening exports and, thus, weakening manufacturing. The uncertainty over Brexit negotiations and Italy and Spain’s faltering economies are causing angst again.

The bond yield curve just keeps getting flatter. While the Fed’s raising of interest rates signals its confidence in the macroeconomic outlook, the curve, or lack there of, continues to be keenly watched by economists and traders around the world. The additional yield one receives on a 10-year Treasury bond is only .27% above the yield on a 2-year treasury**, suggesting that investors and traders do not believe in the long-term strength of our economy. A quarter of a percent is not much of a payday for another 8 years of commitment.

On personal finance

The most mature of the baby boomers will turn 72 this year. This is the wealthiest generation of Americans ever and estimated to be in control $30 trillion of personal assets. If it is not spent and it cannot be taken with them, what is to become of that wealth?

For those that have not settled on a will or trust, their heirs will have to use what one attorney friend calls “the default plan”, the plan the state will impose in lieu of another legal arrangement. The defaults do not consider a family’s values or desires, and will certainly cause some angst among the loved ones. Look to the lack of preparation for the estates of Aretha Franklin and James Brown, whose attorneys should have learned lessons from Howard Hughes and Pablo Picasso, to name only a few of the wealthy whose families used a default plan to settle estates.

To be sure, having a formal plan does not ensure smooth sailing. A plan is just paper and words; true intent and wishes must be communicated in old-fashioned conversations. This is what The Williams Group found in a 20-year study that followed 3,250 wealthy families as they transferred assets to their descendants. 70% of the transfers failed, defined as the “involuntary loss of control of the assets”. Success for the successful 30% was defined as being able to stay in control of the money into following generations and to do so harmoniously.

The study discovered that there was nothing fundamentally wrong with the estate planning, or tax preparation or the execution. The money was lost most often because of poor trust and communication when heirs were not prepared for their roles and responsibilities. To be blunt, the first generation strived to build the wealth, the second spent it and the third started from scratch again.

Regardless of whether you are contemplating a wealth transfer soon or are building your wealth and family, you can sow the seeds for a positive outcome now.

1. Discuss money with your children, no matter their ages. Families talk about all kinds of challenging subjects around the table but regularly avoid finance, which is not a dirty topic and should not be treated that way. Giving money and budgets the proper consideration can create a sense of family responsibility and strength when making decisions, from whether to eat out or how fancy a vacation you all should enjoy.

2. Focus on your values around money. Start by listing your top 3 and compare with each other. It is far more important than discussing how your incomes compare to another family or who seems to be more successful. Do you value nice things or would you prefer to use your money for experiences? What place do charitable gifts have in your life and what causes are closest to your heart?

3. For those with adult children creating their own financial stories, share what is important to you as individual and as a family. Ask what kind of a legacy the family would like to leave and how can everyone work together to achieve that.

Start slowly if this is uncomfortable and chip away at it over time. For those ready to create a will or a trust, we can provide references to vetted attorneys who will listen, advise and complete a plan that will suit your legacy needs today and far into the future.

* FAANG is short for Facebook, Amazon, Apple, Netflix and Google (now Alphabet)

** 10 year UST at 3.09% as of Oct 1st, 2 year UST at 2.82%; https://fred.stlouisfed.org/series/T10Y2Y

DISCLOSURE

Statements on financial markets and economics are based on current market conditions and subject to change without notice. Due to the rapidly changing nature of financial markets, all information, views, opinions and estimates may quickly become outdated and are subject to change or correction. We provide information from reliable sources but should not be assumed accurate or complete.

Investment Advisory Services offered through Integrated Advisors Network LLC (IAN), a Registered Investment Advisor. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.

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