Market Review
The third quarter was entirely driven by three main factors: interest rates, Brexit, and trade.
The Federal Reserve cut rates twice during the quarter, July and September. While the rate cut had its intended effect of driving up markets, we have concerns about the Fed’s positioning. In theory, interest rates are zero bound, meaning that the Fed cannot cut rates below 0%. With the recent rate cuts to 2.00%, if there is a need to drastically cut rates the Fed's ammunition is limited. As a result, we believe the Fed has potentially painted itself into a corner.
Brexit is back in the news and shockingly remains uncertain. The latest vote on Saturday, October 19th, forced Prime Minister Boris Johnson to seek a further extension from the EU. Without the Brexit extension, the deadline is October 31st. If the EU agrees to the extension, it opens the possibility of a general election which could lead to a second referendum.
Trade talks between the US and China are progressing, yet there is little action. The most recent meeting was on October 10th and 11th. The two countries have agreed on China purchasing over $40B of agricultural products. The markets traded higher as a result of the headlines and we expect traders to continue to do what they do best: trade on these headlines. This agreement, while in the right direction, is a drop in the bucket as the trade between the two countries total over $650B a year; we still have a long way to go. The US is a consumer-based economy and China is an export-based economy. The trade deficit is an unsolvable problem as long as we continue to consume what is produced elsewhere. Tariffs are bad for the markets, both economies, and not the answer to the trade deficit.
For the year, the Dow, S&P, and MSCI international index are up 17.5%, 20.6%, and 12.8% respectively. Of course, returns are lumpy as the bulk of the rally was in the first quarter. For the quarter, the Dow, S&P, and the MSCI international index are up 1.8%, 1.7%, and down 1.1% respectively. Year over year, the US index was up less than 5% and the international index
was negative.
Blackjack and 10-Year Projections
Over the summer, we did a thorough examination of the markets and updated our 10-year projections. Based on our analysis, we expect the next 10 years to under-perform the previous 10 years. US equities have effectively been on an upward trend for a decade and we cannot expect it to continue indefinitely.
For those familiar with blackjack and counting cards, we offer this analogy. When you’re counting cards in blackjack, the idea is not to predict when you will hit blackjack. Instead, you are counting to see what cards have been dealt to understand if the odds are in your favor or in the house’s favor. When the odds are in your favor, you bet more and when the odds are less in your favor, you bet less. However, you remain at the table and continue to play regardless of the odds.
So, this is the state we find ourselves in: the odds are not in the investor’s favor. You can take more risk, but we do not believe it will necessarily translate into higher returns. Thus, why take the extra risk?
We will be repositioning the portfolios in the coming months to take some risk off the table for you. We are always looking at full market cycles (over a 10-year plus period) and believe this move will help protect your capital when there is a downturn resulting in a better risk-adjusted return. It is during the downturn that the odds will shift back in your favor.
Rental Cap in California
With the Assembly Bill 1482 (AB1482), the rent control bill signed into law on October 7th, both real estate investors and tenants have been affected. Investors must comply with the new law and tenants should be aware of the proper notice or changes in terms of future rental agreements.
The new law affects multi-unit properties older than 15 years and single-family homes owned by corporations or other institutional investors. Annual rent increase is capped at 5% plus the change in the cost of living or 10%, whichever is lower. In addition, the 15-year rule is a rolling 15-year period, which means a property that is exempt today will not be exempt once it is older than 15 years. The new law also does not override stricter rent control ordinances in place, such as San Francisco.
If you have a multi-unit residential rental property that is self-managed or are renting a property and are uncertain how this impacts you, please call us and we can refer you to counsel. If you have a rental property that is being professionally managed, we encourage you to connect with the property manager to ensure that timely and proper notice is given to your tenant(s) to remain in compliance with the law.
2019 Tax Planning
It’s tax planning time again. Now is the time to take action in preparation for your 2019 taxes, to review and run your personal income tax projections. For many, incomes have gone up, which is great news, but this also means more taxes. To help mitigate the shock that might come up at tax time, we will run an income/ tax projection to estimate your liability for 2019. We started running projections during the summer and have connected with most clients. However, if you have not yet heard from us and would like us to reaffirm your 2019 liability, please contact us and we’ll be happy to run your tax projection.
For those who are charitably inclined and subject to required minimum distributions (RMD), you have the option of donating all or part of the RMD to satisfy the RMD requirement. You also have the option of gifting appreciated stock to avoid capital gains. Charitable contributions must be submitted by December 16th to make sure it will be processed for 2019. We won't spend the time detailing out these options in this newsletter but know these are some of the strategies we are considering as we review and project your taxes.
Mortgage Survey
Mortgage rates have plummeted with the recent Fed rate cuts. Many of you have refinanced over the years so our data on your mortgage may not be up to date. Thus, we will be sending you an online survey soon to obtain the details of your current mortgage. This will help us assess if there is a refinance opportunity for you. In some cases, we have seen a 1% drop in rates through a refinance, saving over $200,000 over the lifetime of the loan. We encourage you to complete the survey. The online form will ask you for your client number which will be enclosed in the email. The client number is designed so that your mortgage information you share is only readable by us to ensure your privacy. Participation is completely optional, but we would encourage you to participate. Alternatively, you can always call us to give us the data over the phone. We’re always available and delighted to chat with you.
As always, we appreciate the confidence you have placed in us to work alongside you regarding your planning needs. Be sure to follow us on Facebook, LinkedIn and Twitter as well as our RSS feed to stay up to date on what we’re reading and thinking.
– The Archvest Team
Archvest Wealth Advisors