Quarterly Reflections - January 2020

Cheers to a new year and another chance for us to get it right. ~ Oprah Winfrey

On the economy

A great deal has already been made of, and printed about, the world’s events over the remarkable last ten years. Now that the calendar has turned over, we will consider what the future could bring.

At this moment, an actual military confrontation seems to be sucking all of the conversational energy away from 2019’s boldest headlines. The aggression and hostility between the U.S., Iraq and Iran deserves close attention and has heightened inter-policy tensions at home.

By comparison, 2019’s stressors seem more manageable. A U.S.-China “Phase One” deal signing is planned for this month. Even if the agreement looks to be mostly ornamental, it does indicate soothed feelings on both sides. The United Kingdom and European Union gained some near-term clarity with Boris “Brexit or bust” Johnson’s landslide win. Although the exit will still be bumpy, the U.K.-E.U. conscious uncoupling is sure to occur. Then there is impeachment. Much like with President Clinton’s in 1998, it will not bring any governance upheaval but rather be a personal asterisk next to President Trump’s name in the history books. The voters will get the definitive say on November 3rd.

As these risks gloriously abate, investors will be free to focus on the traditional drivers of markets, especially earnings growth.

As mentioned in October, the Federal Reserves’ rate reduction ultimately became a third reset for this record-breaking economic expansion. The Fed and any further interest rate moves are on hold as far as we can see. Bankers around the world are also standing pat on rate changes with accommodative stances. Combined with more certain global trade policies, the trickle-down effects should bring calm in 2020, particularly for foreign and emerging economies.

Thus, living in fear of a recession does not seem reasonable but living in realization of the risks is a grand idea. There are still plenty of struggling middle-class and poor families. We particularly know this after last year’s government shutdown exercise when we learned too many could not afford an unexpected $400 expense. Businesses continue to decrease spending especially since last summer. And there are massive debt excesses in the system – yes, student and corporate debt, we see you. But while the three amigos of low interest rates, low inflation and low unemployment remain stable, a chance of a near-term blow-up in the economy seems faint.

On the markets

The markets have made a remarkable recovery since the steep correction in 2018. Just 18 months ago, investors became deeply rattled due to near-daily policy uncertainty, an escalating trade war and the determined Fed’s rate hike plan. A new year gave way to a softer landing on those issues and prompted 2019’s rally, which was also nurtured without any meaningful earnings growth. Let’s look back.

Stock returns and earnings where most decidedly not in sync in 2018.

From August 2018’s peak to December’s trough, the S&P 500 index lost 13.5% and ended the year down 4.8%. Simultaneously, publicly traded companies grew their earnings by over 20% with the aid of sharply-lower taxes and a harmonious global economy.

That story reversed in 2019. Publicly traded companies did not deliver on earnings growth. While final tallies are still being made, overall earnings were anemic through September; only as we get more data and are able to factor in 4th quarter earnings, do we see a meaningful uptick. The S&P 500 index by contrast was up 30%.

Throughout this period, the confused investor next door made some unfortunate investment decisions. Per J.P. Morgan’s 2020 Outlook, “2019 was a very unusual year in terms of the behavior of retail investors, with close to record-high bond fund buying and record-high equity fund selling. In 2019, bond fund demand from retail investors reached a record high […] while retail investors sold equity funds at the strongest pace since 2008”.

Speaking to bonds, the yield curve has normalized and once again investors can receive better rates on a 10-year than on a 3-month issue. For now, that signifies optimism.

On personal finance

Although the House of Representatives passed the Setting Every Community Up for Retirement Enhancement Act of 2019, it was not expected to become law anytime soon. However, as so often happens in Washington D.C., the legislation was tucked into the 2020 spending bill and unexpectedly signed in December.

Cleverly called the SECURE Act, it brings several notable changes to retirement planning that are important to note.

The Required Minimum Distribution age has been pushed back to age 72 from the somewhat awkward 70.5 age. Anyone turning 70.5 in 2020 or beyond may now wait until age 72 to begin required distributions. To make it extra simple, those born on or before June 30, 1949 must begin distributions at 70.5. Those born after may relax until age 72.

There is no longer an upper age limit for IRA contributions as of January 1st. Now anyone with earned income can put away some of that into a traditional IRA or a Roth, if you meet the income limitations. It’s entirely possible to make IRA contributions and mandatory IRA withdrawals in the same year. How fun.

The Stretch IRA opportunity for non-spouse heirs to “stretch” inherited IRA withdrawals over their own lifetimes has been removed. This is a disappointment for many who hoped that younger beneficiaries would have ample years to drawdown a tax-sheltered account. Previously heirs made required annual distributions based on their own (usually longer) life expectancy. Now heirs must withdraw the entire IRA value within 10 years. There are few exceptions to the 10-year rule. Poor planning here could see beneficiaries forced to take larger distributions, resulting in higher taxes, depending on the situation.