On January 2nd, wasting no time shifting from holiday cheer to market chatter, Bloomberg published an article titled “Almost Everything Wall Street Expects in 2020.” Clocking in just shy of 35,000 words, it’s a doozy. After removing generic terms such as “2020” and “investments,” here are the 15 most-used words in the article –

1. Growth (409) 6. Expectations (223) 11. Banks (131)
2. Risk (311) 7. Trade (217) 12. Yield (119)
3. Economy (309) 8. Equities (167) 13. Recession (117)
4. Markets (288) 9. Policy (148) 14. Elections (109)
5. Global (287) 10. China (136) 15. Volatility (106)

We always take pride in cutting through the noise (35,000 words are a lot of noise). So, here’s Planning Capital’s 2020 Outlook if we just use these top 15 words –

“Growth expectations remain solid for equities against the backdrop of trade risk in increasingly global markets. Negotiations with China and elections will likely stoke the flames of volatility as investors wonder if the economy is on the brink of the next recession. Central banks continue to wrestle with interest rate policy, making it more difficult to get yield in an overvalued market.”

How poignant. But the million-dollar question remains—can the market really keep going up? Second, in a more “rubber meets the road” topic, we’ll distill the SECURE Act down to its important parts and help you determine if it applies to you (hint: it applies to every American who plans on retiring).  Lastly, as we celebrate the one-year anniversary of our Philadelphia office, we remember the anniversary of another financial organization opening its doors in the City of Brotherly Love some 238 years ago.

“I Knew the Record Would Stand Until It Was Broken”

Market prognosticators must feel like Yogi Berra. The Yankees’ catcher is known for his colloquial sayings, which are famously free from the confines of logic. We’ve seen similar phenomena when reading about markets lately. For example: “valuations say stocks are cheap and expensive[1],” “buying and selling stocks isn’t always easy[2],” and “investors aren’t worried that stocks are climbing[3].” This last one has a particularly Yogi-esque sentiment; obviously Americans aren’t worried that their investments are growing—that’s the whole point!

The headlines that all of us are seeing are so uninspiring, generic, and sometimes contradictory because nobody has a clue what happens next. JP Morgan has an incredible economic team and publishes an annual guide to the markets, complete with a two-hour seminar and thoroughly researched paper. They placed the probability of a recession in the next 12 months at 50%. RBC conducts a quarterly survey of investor sentiment, which most recently clocked in at 50% bullish and 50% bearish. Report after report reads the same way—the experts are recommending a coin flip.

Forget heads or tails, here’s the good news and bad news heading into 2020 –

  • Bad News: The Federal Reserve is making itself ineffective

The Fed cut interest rates 6.75% in the 1987-1989 recession, 5.5% in the 2001 recession, and 5% in the 2007-2009 recession. Currently, it only has enough room to cut rates by 1.5% without going negative[4]. This is an issue because traditional monetary policy will have a tough time combatting a recession.

  • Good News: The economic diagnosis is very positive

Home building, capital spending, vehicle sales, and inventory are often considered to be the “four horsemen of economic apocalypse.” They collectively account for only about 20% of GDP, but typically all will show signs of weakness before bottoming out in a recession. Currently, none are overextended. With the unusually resilient American consumer accounting for another 70% of GDP, the vital signs of U.S. economic health are well within range.

  • Bad News: Liquidity is drying up

In September, an unexpected shortage of available cash to lend sparked a surge in the cost of repo-market borrowing (bank to bank lending), prompting the Fed to intervene for the first time since the financial crisis. This appears not to be an isolated incident—the Fed is considering a new tool to ease this liquidity issue which involves direct lending to hedge funds[5]. Volatility in short-term cash markets is never a good sign, but this is a sign of insanity.

  • Good News: A trade deal with China is in sight

The U.S. and China will sign the first phase of a trade deal that will include roughly $200 billion in Chinese purchases of American goods and services over the next two years, in exchange for the U.S. cancelling new tariffs on roughly $156 billion in Chinese imports and cutting in half the existing 15% tariff rate on roughly $120 billion of Chinese goods[6]. Trade policy chatter has rattled markets since Trump took office, so any steps towards normalcy are a welcome change.

  • Bad News: Corporate earnings are not looking good

Corporate earnings have posted four straight quarters of declines[7]. This isn’t rocket science—companies need to grow revenue to grow their stock price.

  • Good News: Global economies are showing signs of life

With negative interest rates and strong U.S. growth, international developed nations have been struggling to grow for the past several years. Given the still-healthy consumer, gradual fading of trade tensions, and recent improvement in global manufacturing data, indicators show that the global economy is shifting from contraction to expansion mode for the first time since 2015[8].

The S&P 500 has set 16 record highs in the past 12 months (as of 1/15/2020). The only thing we can say for sure is that the current record will stand; until it is broken.

I’m Calling Security!

Government is obsessed with acronyms to the point that it’s virtually impossible to count how many are used between different agencies, legislation, and programs. In 2020, the pantheon has grown as the Setting Every Community Up for Retirement Enhancement (SECURE) Act was recently passed. It changes some of the longest-standing rules surrounding retirement accounts.

Age 70 ½ has been the line in the sand where retirement contributions turn into distributions since 1986 with the Tax Reform Act under Ronald Reagan. Under this law, account holders were required to take a distribution (forcing taxable income) and were not allowed to make a contribution (prohibiting tax deductions) once reaching this age. It’s been a central tenet of retirement planning for over 30 years.

Both rules are now changed and decoupled to reflect the reality of Americans working and living longer. Required minimum distributions (RMDs) will now start for account holders in the year they turn age 72. Perhaps more importantly, traditional IRA account owners may continue to make contributions so long as they are working and have earned income[9]. This is a great strategy to offset income tax burdens for individuals working into their 70s who are required to take IRA distributions.

The third major change that we want to point out is one that may take people by surprise—inherited IRAs are no longer allowed. This does not change how IRAs pass on to a spousal beneficiary at death, but the “stretch” option for non-spouse beneficiaries has been eliminated. These beneficiaries (children, grandchildren, etc.) can no longer take RMDs over their own life expectancies. Instead, they will be required to deplete the inherited balance within 10 years of the decedent’s death. Luckily, inherited IRAs established prior to 2020 will continue uninterrupted[10].

This brings up various planning considerations for both IRA owners and beneficiaries, mostly focused on tax issues. The 10-year distribution period means that the amount of taxable income will be much greater than if stretched over a life expectancy—especially troubling for beneficiaries who are high-income earners, inheriting a large IRA balance, or both.

IRA owners should review the primary and contingent beneficiaries for their accounts. For any non-spouses that are listed, a bit of forward-thinking estate planning is necessary. Talk to your beneficiaries about their financial situation to determine if taxes will be an issue. If you have other assets, it may be advisable to change who inherits what based on the discussion. We always encourage open, honest communication around this topic.

IRA inheritors sometimes cannot avoid inheriting the asset (even if there is a known tax issue) or are caught by surprise when there was not open communication in estate planning. It is highly preferred to have these discussions because these strategies must be enacted before the asset is inherited.

Roth conversions are an attractive option since these accounts are not subject to required distributions and tax will have to be paid either way. The catch is that it must be done by the account owner (once the asset is inherited this cannot be done). Charitable trusts and retirement asset trusts will also likely be good options to explore, as they can be listed as beneficiaries and provide income to the next generation. Unfortunately, unless these options were considered by the IRA owner before death, many inheritors will be stuck with a tax bill they didn’t see coming.

Philadelphia: Come for the Cheesesteaks, Stay for the Central Banking

As the Federal Reserve dominates the news cycle, we are reminded that our own backyard, in Philadelphia’s historic Old City, is home to the vestiges of two earlier attempts at a central bank. These were not about helicopter money, quantitative easing, or any of the other esoteric functions that the Fed now performs. They were the brainchild of Founding Father Alexander Hamilton and sought to re-establish commerce, repay debt, restore currency value, and lower inflation (okay, that was the same).

The First Bank of the United States, located at 128 South 3rd Street, was given a 20-year charter in 1791 after the Revolutionary War created chaos in the U.S. financial system. The new system was based on the concept of public credit (government bonds) which exists to this day. Hamilton knew that the recently independent nation would need a reliable system to encourage investment into U.S. securities, which were starting to develop a bad reputation. The Federalists’ success in winning approval for Hamilton’s reforms led to the emergence of an opposition party who questioned the constitutionality of a central bank—the Democratic-Republicans. That’s right, we all used to be on the same side!

The Democratic-Republicans did not renew the First Bank’s charter. But 5 years after it expired, the nation had the same objectives after the War of 1812 and decided to give it another shot. The Second Bank of the United States was given a 20-year charter in 1816, located at 420 Chestnut Street, and shared a lawn with the First Bank. This time around was different. The Supreme Court affirmed the constitutionality of the bank, public perceptions were positive, and the bank opened 26 branches across the country. The federal government was the bank’s single largest stockholder at 20%, and the rest was owned by private entities, including one thousand Europeans, with the bulk of the stocks held by a few hundred wealthy Americans. It was the largest corporation in the world at the time.

Both banks were met with significant opposition because they made the “central” in central banking very literal—each were the only federal bank at the time. The Second Bank appeared to be on solid footing until Andrew Jackson became president, labeled the bank as a corrupt institution, ran for re-election on his anti-bank platform, won, and broke it up.

It wouldn’t be for almost another 80 years that central banking came back to the United States, after financial panics kept reverberating through the system since the Civil War. When President Woodrow Wilson signed the Federal Reserve Act into law in 1913, it included the ingenious compromise of decentralized central banking. The Federal Open Market Committee was then added in 1935 to create the system in place to this day. A Board of Governors and 12 Reserve Banks comprise the Federal Reserve system—one being the Philadelphia Federal Reserve.

We hope you enjoyed our comments. If you have any questions, please do not hesitate to contact us. We welcome the opportunity to discuss our thoughts in greater detail. Thank you for your continued confidence in Planning Capital Management.

[1] Liz Ann Sonders, “Valuations Say Stocks are Cheap and Expensive”, Schwab Market Commentary, 2 Dec 2019

[2] Gunjan Banerji, “Buying or Selling Stocks? It Isn’t Always Easy”, The Wall Street Journal, 2 Jan 2020

[3] Michael Wursthorn, “Stocks Are Climbing Faster Than Profits”, The Wall Street Journal, 24 Dec 2019

[4] Reade Pickert, “U.S. Recession Odds Steady as Stocks Reach Fresh Record”, Bloomberg, 11 Dec 2019

[5] Daniel Kruger, “Hedge Funds Make Fed Repo-Market Fix Hard to Stomach”, The Wall Street Journal, 14 Jan 2020

[6] Lingling Wei, “U.S., China to Sign Deal Easing Trade Tensions”, The Wall Street Journal, 15 Jan 2020

[7] Akane Otani, “Investors Are Counting on Earnings to Rebound in 2020”, The Wall Street Journal, 13 Jan 2020

[8] Jeffrey Kleintop, “Are We There Yet?”, Schwab Market Perspective, 9 Jan 2020

[9] Elizabeth O’Brien, “Congress Passed the Biggest Retirement Bill in More Than a Decade”, Money, 19 Dec 2019

[10] Darla Mercado, “5 tips to consider before the stretch IRA dies out”, CNBC, 11 Jun 2019