Author: Ryan Hughes

2/6/2018 - The previous couple of days have been volatile given the recent market decline. Within the past few days (Jan 26 -  Feb 5) the market fell nearly -8%. On Monday (Feb 5th) alone the S&P 500 fell -4.1%.

S&P 500 since Jan 2017

If you watch CNBC, read Yahoo Finance, or consume any other financial media, the reasoning behind this sharp downturn is likely to be due to "inflation fears," "geopolitical instability," "central bank tightening," or even "a fat-finger on a trading desk spurring a massive sell-off."

I suppose these could all be factors, but I find it hard to believe that these fears are suddenly manifest when last week they were only minor concerns. Instead, I would like to offer another explanation. Perhaps the stock market is going down simply because it went up for too long. Yes, I know this isn't a sophisticated answer and it's probably an answer you weren't expecting. But not all answers have to be complex and difficult to understand. The S&P 500 was incredible in 2016 & 2017 as it climbed the wall of worry and it did so with nearly no declines. Market volatility was essentially non-existent despite high valuations.

VIX since Jan 2016

I believe the past few days to be a garden-variety correction. And keep in mind that a market correction is defined as -10% pullback. It may not feel like it because this has been a sharp decline. The difference in today's market vs. those in the past is that the market simply moves faster than it has in the past. And for those of you that follow my investment philosophy, you know that I believe this is due to accelerating information diffusion (the speed at which information spreads throughout the marketplace). The crux of this idea is that investors are better informed because everybody is better connected. This leads to a more efficient market where managers that attempt to outperform benchmarks rarely do so. And thus, market declines are sharper.

I spoke to a very good friend and finance colleague about this yesterday and I believe he said it best, "This stock market selloff the past few days is price discovery with a splash of overshoot." Perhaps overshoot is an understatement. A generous pour is more like it.

Is the market selloff done? Maybe. I don't know. The market recovered a bit today, but one day does not make a trend. Keep in mind that the stock market just had a record-breaking year. The fundamentals within the overall economy have not changed so I would be hard-pressed to think that this correction will turn into the "big one."

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter

 

 


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.

1/13/2018 - It means that your tax strategy is likely to change. I wrote about the the possible effects of the Tax Reform and Jobs Act of 2017 for California residents last month before the final bill was passed. The punchline? If you live in a high income-tax state, the lower brackets do not help out as much as you would think. However, CA state lawmakers may have a way for its residents to avoid the $10,000 SALT (state and local income tax) deduction limit, which is now part of the new federal tax law. See below where I discuss this further.

I also wanted to provide an overview of what this new tax law means. But before we jump into the overview, it is important to point out the massive federal tax revenue hit this bill will create. According to the nonpartisan Joint Committee on Taxation, there will be an estimates $1.46 trillion revenue reduction over the next 10 years. Furthermore, a lot of these tax cuts are temporary while providing a major tax cut for wealthy individuals that live in low/no income tax states. How this will affect the greater economy going forward remains to be seen. Though, I would assume the economic benefits promised are exaggerated at best.

Eric Sussman, a popular finance professor at UCLA Anderson (my alma mater), wrote on this topic where he provided an excellent argument as to why this will create a short-term boost to the markets but a long-term drag to the overall economy.  I highly suggest all interested to read his analysis.

Tax Reform Overview

2018 Federal Income Tax Brackets
Tax RateSingleMarried, Filing Jointly
10%Up to $9,525Up to $19,050
12%$9,526-$38,700$19,051-$77,400
22%$38,701-$82,500$77,401-$165,000
24%$82,501-$157,500$165,001-$315,000
32%$157,501-$200,000$315,001-$400,000
35%$200,001-$500,000$400,001-$600,000
37%Over $500,000Over $600,000

Standard Deduction. The standard deduction amount has increased A LOT. The new amounts are as follows:

- Married Filing Jointly/Surviving Spouse: $24,000
- Head of Household: $18,000
- Single: $12,000
- Married Filing Separately: $12,000

State and Local Income Tax (SALT). State and local income and property taxes will be deductable up to a combined $10,000 cap. This means that most individuals will likely be filing with the standard deduction.

Alternative Minimum Tax. The AMT exemption amount will increase to $70,300 for single filers and $109,400 for MFJ and will phase out for those filers at $500,000 and $1MM respectively.

Capital Gains Tax Rate. There is no change to the tax law. For most investors, the long-term capital gains rate will be 0%, 15%, or 20%.

Estate Tax. The 40% estate tax rate would apply to estates valued at $11.2MM for a single filer or $22.4MM for couples.

Corporate Tax. Over a year when President Trump was just elected president, I wrote about the possible effect to stock prices a lower corporate tax rate would have. I suspected the tax rate would be closer to 20%, rather than the 15% he first propsed. I was very close to the actual rate, which is now 21%. Additionally, the corporate AMT is now repealed. A reason why the stock market has rallied for the past 14 months is partially due to the probablility of lower corporate taxes. I plan to write about this some more in the future.

Small Businesses and Pass-Through Entities. Small business owners can now take a 20% deduction on their pass-through business entity, which includes sole proprietors, LLCs, C-Corps, S-Corps, etc. What does this mean? "Business income that passes through to an individual from a pass-through entity and income attributable to a sole proprietorship will be taxed at individual tax rates less a deduction of up to 20% to bring the rate lower. (Forbes) Sound confusing? It is. There are limits and restrictions and it requires a bit more study to better understand.

529 College Savings Plans. Traditionally, 529s could only be used for qualified higher-education expenses (tuition, books, etc.). Now, account holders can use 529 funds (up to $10,000 per year) towards elementary or secondary public, private, or religious school tuition.

New Way To Avoid SALT Deductions?

State and Local Income Tax

As mentioned earlier, one of the biggest consequential measures for California residents is the $10,000 federal cap on SALT (state and local income tax) deductions. The average SALT deduction claimed by Californians is over $22,000, well above the cap.

Last week, Kevin de Leon proposed a workaround the SALT cap. The bill would allows its filers to make a charitable contribution to the state in exchange for a tax credit. The tax filer would then deduct that contribution on their federal return since the new law doesn't cap deductible charitable contributions unless it exceed 60% of your adjusted gross income.

Example: Lets assume that you have to pay $50,000 in state income and property taxes in 2018. You may only deduct $10,000 of that on your federal return. To help you preserve the deduction for the remaining $40,000, California would let you make a $40,000 charitable contribution to the state in exchange for a $40,000 tax credit on your CA state tax return.

New York, New Jersey, Illinois, and other high income-tax states are also considering similar strategies. But are charitable contributions to states permitted under the Internal Revenue Code? Yes. In fact, there is already precedent of the IRS and the courts supporting the full deductibility of charitable contributions to states in other circumstances. So watch out, this may become a real law sooner rather than later.

 

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
1/13/2018

 
 
 

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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.

12/8/17 - Contrary to popular belief, according to our analysis, for those that live in a high income tax state, the proposed tax bills will likely BENEFIT lower-income and middle-class individuals and families while driving higher tax rates for the upper-class. The primary reasons why? The child tax credit is increased in both the house ($1,000 to $1,600) and the senate ($1,000 to $2,000), the standard deduction is increased ($6,350 to $12,000/$12,200), the tax brackets have been lowered, and the personal exemptions have been eliminated. All of these favor the lower and middle classes while negatively impacting the upper-class.

As a recap, the Republican House of Representatives and the Senate have each put together their own version of a new tax bill. 

GOP Tax Plan for Single FilersGOP Tax Plan for Married Filing Jointly

Republicans hope to merge the two bills into a unified version and to present it to the President by the end of the year. The question of, "Will I pay more taxes?" or "Does this bill tax the lower-income and middle-class more and give a tax break to the rich?" is one that many, including myself, have asked.

This is a very complicated question as its answer depends upon a number of specific circumstances. As a number of my clients are high-income married individuals that reside in a high-income tax state (California and New York). I wanted to see how each tax bill would affect them.

Our Tax Scenarios

Brody Rosenfeld, CPA, a financial planner for Bull Oak Capital, has put together a fantastic model comparing 1. the current tax code, 2. the House proposed tax bill, and 3. the Senate proposed tax bill. (As a side note, this analysis was performed on 12/7/17 and I'm sure many changes to these bills will occur in the near future). Keep in mind that the current tax code is a very complex one and we were not able to completely build it out. For example, we did not account for AMT as it is highly complex and scenario dependent. Likewise, we had make a few assumptions when building out these scenarios. Does the tax filer own a home and do they have a mortgage? If so, what is their mortgage rate and their subsequent payment? Where are they currently on the amortization schedule? That being said, the point of this exercise was to give us a broad-based view of the current proposals based on today's environment (current mortgage rates, tax rates, etc.). To compare apples-to-apples, we analyzed what effect these tax bills would have on a California married couple with 2 children. We ran 4 scenarios:

1. Married with 2 Dependent Kids - $70k income in California
2. Married with 2 Dependent Kids - $150k income in California
3. Married with 2 Dependent Kids - $300k income in California
4. Married with 2 Dependent Kids - $600k income in California

To create a scenario that would benefit a high-income earner, we ran an additional scenario:

5. Married with 0 Dependent Kids - $600k income in a Tax-Free State (e.g. Wyoming, Florida, etc.)

Here are the results.

Married, 2 Kids - $70k Income in CA

Both the House and Senate bill clearly favor this client. This scenario analyzes the potential effect of tax law changes on a couple with two dependent children earning $70,000/year in California. The client takes the standard deduction as the $3,115 California state tax does not exceed the standard deduction under current laws. Additionally, the client qualifies for the child tax credit. As this credit is increased in both the house ($1,000 to $1,600) and senate ($1,000 to $2,000) bills the client will see a substantial tax reduction.

Married, 2 Kids - $150k Income in CA

The scale of this chart may be misleading as there is a very small change between the current tax law and both proposed bills. This scenario analyzes the potential effect of tax law changes on a couple with two dependent children earning $150,000/year in California. The client currently itemizes deductions totaling $20,555. This is less than the increased standard deduction on the proposed bills. The client also does not qualify for the child tax credit due to income. Taxes are almost flat with the House bill while they increase slightly with the Senate bill. This is due to higher taxable income driven by the proposed bills elimination of the personal exemption.

Married, 2 Kids - $300k Income in CA

Under this scenario, the client begins to feel the impact of the lack of itemized deductions and child tax credits. This scenario analyzes the potential effect of tax law changes on a couple with two dependent children earning $300,000/year in California. The client currently itemizes deductions totaling $59,521. Itemized deductions for Taxes Paid are reduced in the proposed bills leading to higher taxable income. The client also does not qualify for the child tax credit due to income. Taxes increase for both bills driven by the limitations on itemized deductions related to California Income Tax & Property Taxes. As the client's assumed mortgage was $500,000 they were still able to deduct the interest on it.

Married, 2 Kids - $600k Income in CA

This scenario analyzes the potential effect of tax law changes on a couple with two dependent children earning $600,000/year in California. The client currently itemizes deductions totaling $128,323. Itemized deductions for Taxes Paid are reduced in the proposed bills leading to higher taxable income. The client also does not qualify for the child tax credit due to income. Taxes increase for both bills driven by the limitations on itemized deductions related to California Income Tax & Property Taxes. As the client's assumed mortgage was $1,000,000 so deductibility of interest was capped on the proposed bills.

Married with No Kids - $600k Income in Tax-Free State

For this scenario, we wanted to see which high-income earners would benefit under the proposed tax plans. This scenario analyzes the potential effect of tax law changes on a couple with no dependent children earning $600,000/year in a tax-free state. To accomplish this, we had to assume that the client currently takes the standard deduction, they are renters with no children, and they live in a state that has no income tax. Taxes decrease for both bills driven by the increase of the standard deduction and reduction of bracket rates.

In short, the proposed tax bills benefits those with lower incomes as the standard deduction and the child tax credit limits are higher. Likewise, the removal of a number of different deductions, including student loan interest, medical and dental expenses, and personal exemptions (a big deal for Californians) drive a higher overall federal tax bill for higher-income earners. Of course, no bill has yet to pass so these issues may well very change before they are placed in front of the President.

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
12/8/2017

Bull Oak Capital, LLC

 

 


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.

11/16/2017 - Perhaps. For most, it makes sense to roll your funds out of a 401k (this includes a 403b, 401a, or whatever type the deferred employer plan may be). Though, there are a few exceptions that one must consider before pulling the trigger. This includes fees, any concentrated stock positions, and other company benefits.

When you leave your company, you essentially have four 401k options to consider.

Your Four 401k Options

1. Completely cash-out your funds from your 401k (not recommended)
- You do NOT want to do this outside of any cosmic cataclysmic circumstances (e.g. the apocalypse has arrived, the moon is crashing into the Earth, etc.).
- If you do, be prepared to pay the IRS as this is considered a taxable event. I recommend that you talk to a tax professional before you consider this option. 401k distributions can be taxed at the ordinary tax rate plus a 10% penalty if you are under 59 ½ years of age.

2. Leave your funds at the old 401k

3. Roll your funds to a new 401k (your new employer)

4. Roll your funds into a Rollover IRA (Individual Retirement Account)

Of these four options, there are really only three non-taxable paths you will want to consider: Leave your funds where they are, roll them over to another 401k, and roll them over to an IRA.

Source: 401krollover

Reasons To Keep Funds At 401k

Option 2 & 3: There are a few good reasons why you would want to keep your funds at a 401k plan. The biggest reasons include:

1. Lower Fees: If the plan has rock-bottom fees, then it probably makes sense to have your funds there, whether it is the old or the new 401k plan. Though, most discount brokerage companies have access to extremely cheap products, such as Index ETFs (e.g. Charles Schwab, TD Ameritrade, etc.)

2. Stronger Protection Against Lawsuits: 401ks are protected against lawsuits and bankruptcies while IRAs are only protected against bankruptcies up to $1.28MM.

3. Ability to Borrow Against Funds: You cannot borrow against an IRA, but some employers allow their employees to borrow against their 401k balance (amount depends upon the plan). While I rarely think this is a good idea, it may be helpful under certain circumstances.

Why You Should Rollover To IRA

Option 4: While credit protection is weaker and while you cannot "borrow" against an IRA, there are many advantages to rolling your funds to an IRA. These include:

1. Better Investment Options: 401k’s are notoriously limited with their investment options. IRAs open the investment universe to all mutual funds, individual stocks and bonds, ETFs (my favorite), and thousands and thousands of others. You can also hire an investment advisor to manage your IRA if you are unwilling/unable to (like us!).

2. Roth IRAs: Most 401k's do not offer a Roth option.  As a recap, a Roth IRA requires you to pay tax at the point that you put funds into the Roth, but grows tax free and can be distributed tax. This can provide tremendous value down the line. If you have a Traditional/Rollover IRA, you have the option of converting this account to a Roth. We work with the best Tax Attorneys/CPAs in San Diego when considering and planning for this option.

3. Can Take Early Distributions From A Roth: Well, technically these aren't "early" distributions, but you can take money out of the account penalty free if you're under 59 1/2 years old. Of course, there are exceptions (contributions vs. earnings, down-payment for your first home, etc.), but the flexibility the account offers is fantastic.

4. Fewer Rules / Greater Opportunities: 401k's are heavily regulated, limiting the number of investment opportunities available to those accounts. IRAs are standardized by the IRS, allowing multiple brokerages to follow the same rules.

5. Better Beneficiary Selections: IRAs often allow greater flexibility when selecting your beneficiary. Many 401ks usually offer only one primary beneficiary.

6. Consolidation: Most people have 7 careers throughout their lifetime, often leaving old 401k's behind. Keeping your funds within one single acocunt can make your financial life simpler. Rolling your 401k into an IRA is a free, tax-advantaged process.

If you are considering rolling over your 401k and would like guidance on the procedure, we are more than happy to answer any questions you may have. Please do not hesitate to contact us.

 

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
11/16/2017


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.

10/16/2017 - Because it probably won't happen. Is it at least possible for you (or your fund) to beat the index? Of course it is, but it depends on which market you are playing in, your access to key information, your skill, and your luck. But in the end, the odds are simply stacked against you.

US SPIVA
US SPIVA

One of my favorite reports to read is the SPIVA U.S. Scorecard. SPIVA (S&P Indices Versus Active) publishes statistics about the performance of active funds versus the performance of their benchmarks. For those that do not know, the active versus passive debate has been going on for decades. The debate boils down to one factor: does the fund manager (active manager) believe he/she can outperform the fund's underlying index?

The answer is that passive management easily beats active management in just about every U.S. category.

The most important line item is the Large Cap category, which is the most popular and the most influential. 56.56% of funds were out performed by the S&P 500. Or a better way to phrase it, only 43.44% of funds outperformed the benchmark.

It gets worse as you increase the time horizon. Only 18.15% beat over the previous 3 years. And only 6.82% beat over the previous 15 years. In other words, if you were to invest in a random active mutual fund 15 years ago, you would only have a 6.82% chance of that fund outperforming the index.

FYI - S&P does a great job to ensure that this data is as realistic and correct as possible. They correct for survivorship bias, style consistency, asset-weighted returns, etc.

International Markets A Little Better

Other countries are not nearly as efficient as the U.S., giving managers a better chance of outperforming. Still, the odds are not in their favor.

Europe SPIVA
Europe SPIVA
India SPIVA
India SPIVA
Japan SPIVA
Japan SPIVA

What About Past Performance?

Most investors look at a manager's past performance when determining whether or not invest. One of the most important measurements is whether or not the manager can deliver above-average returns over multiple periods. However, outperforming over time has also proven to be difficult.

"An inverse relationship generally exists between the measurement time horizon and the ability of top-performing funds to maintain their status. It is worth noting that less than 1% of large-cap funds and no mid-cap or small-cap funds managed to remain in the top quartile at the end of the five-year measurement period. This figure paints a negative picture regarding the lack of long-term persistence in mutual fund returns." (S&P Persistence)

Bottom Line

As many of you know, Bull Oak Capital only invests in passive index ETFs because of this data. The odds of outperformance at the sub-asset class level is low. So why play the game? Many managers will argue that they are able to exploit inefficiencies in the market and capture that value (alpha). Perhaps they can, but most cannot. For those that have, I have a few questions:

  • Can you recreate your methodology and be able to capture that value year-over-year in a consistent manner? FYI - Managers that have proven to do this are household names and billionaires.
  • How much of that outperformance (if any) is due to skill versus luck? Are you simply riding momentum or are you style drifting?
  • How much of your outperformance is due to luck?

The truth is that most individuals can't tell whether or not a fund manager is skillful or lucky. Persistence is one important measure to test this, but not the only one. Better to not play the game at all in an effort to keep your pocketbook and sanity levels high.

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
10/16/2017


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.

7/11/2017 – Global inflation has been stubbornly low for quite some time, creating a difficult situation for central bankers. Of course, central bank action is highly dependent upon inflation levels. And their actions have direct and immediate influence on global stock and bond prices. The problem? U.S. inflation measured by the core PCE has undershot the Fed’s target rate of 2.0% for the previous 59 months.

As a recap, core PCE (personal consumption expenditure) excludes energy and food prices as they are extremely volatile (a breakdown of PCE is here). According to traditional economics, as the economy continues its recovery and as the unemployment level falls, the price for goods and services should rise. The logic behind this idea is that the U.S. economy is driven by its consumers (71% of U.S. GDP is consumption). So, as the economy recovers, it is safe to assume that consumption increases. Therefore, businesses selling goods and services to consumers should be able to increase price, which increases their profits.

However, we have not been seeing this, even with the unemployment rate falling to pre-2008 levels and as the economy has continued to hire workers.

U.S. Unemployment Rate. Source: Bureau of Labor Statistics

A few factors that might help explain why inflation remains stubbornly low include money not in circulation, the fall in the price of oil, and price discovery.

QE: $ not in circulation

When the topic of inflation comes up during a meeting with my clients, many mention the Federal Reserve’s “printing press.” The argument goes something like this, “If the Fed has printed all of money via quantitative easing, wouldn’t that lead to a devaluation of the U.S. Dollar, and subsequent higher levels of inflation?” Well, the simple answer should be yes, but there is a critical piece missing in all of this. The trillions of dollars (yes, trillions) that the Fed “printed” from 2008 to 2014 has not entered the economy.

Federa Reserve Balance Sheet. Source: federalreserve.gov

Quantitative Easing is not akin to printing money. QE is the process by which a central bank will purchase financial securities (usually government bonds) with a money supply that is created from the Fed. In this case, the Fed purchased the majority of those securities (bonds) directly from the U.S. Treasury. Those securities has been sitting on the Fed’s balance sheet. However, the Fed has recently hinted that they might begin to unwind these positions.

The vast majority of the cash that the Fed used to pay for these securities has found its way back to the Federal Reserve as “excess reserves” (red more on this topic here). This means that of all the dollars “printed,” the vast majority of it is not in circulation. Rather, it is on deposit at the Federal Reserve. The actual amount of currency in circulation has been increasing, but at a very gradual rate.

Currency in circulation vs. institution deposits. Source: federalreserve.org

Oil Has Collapsed

One critical reason why inflation has underperformed can be attributed to the dramatic fall in oil.

Oil is a major input in the global economy. It fuels transportation, warms homes, and is used in the making most products. If the price of oil were to rise, so would the end price to the consumer. As such, the price of oil fell over the past several years. Companies did not pass this cost savings back to the consumer. Rather, it kept those savings while keeping prices relatively stable, hampering inflationary efforts.

Amazon’s Price Discovery: Impact of Technology on Inflation

Price discovery is the process of which a marketplace (buyers and sellers) determines the price of an asset. The more information that is readily available, the more accurate the price will be to its intrinsic value. While price discovery is typically used a term when talking about stocks, futures, options, etc., it can also be used in day-to-day transactions (e.g. grocery shopping, car buying, etc.).

As technological advances continue, more and more people are connected to the online world. And with this connection, we have access to an endless amount of information. While access to the internet (whether it be from your home or work computer or your cell phone) has definitely had an impact, I think the bigger impact is Amazon.

Amazon has an incredible 43% marketshare of all online retail sales and 53% of all online sales growth in the U.S. (Slice)

It’s giant scale and automation has allowed it to compete, and win, against some of the world’s largest retailers. Simply put, these traditional retailers are having a very difficult time competing against a business that is willing to operate at a 1% margin. This has allowed Amazon to grow at an blistering pace, stealing marketshare from long-standing traditional retailers. And Amazon’s presence has allowed anyone with a cell phone or a computer to have fast and easy price discovery, often times between multiple sellers on Amazon’s platform. Amazon has brilliantly positioned itself as a market provider, not as a product provider.

Because consumers now have the ability to shop for different products and the ability to compare them against each other, this makes for a more competitive marketplace. And as the level of competition increases, the applied pressure on price increases.

Bottom Line

While these three examples may explain part of the reason why inflation levels have been so low, it likely does not explain the entire reason. Some would argue that a stagnant economy can be to blame. However, the global economy has been growing at a faster rate during the previous year, yet inflation still remains low. The question is now whether central bank intervention will finally overcome these previous inflationary headwinds in the near future. Remember, the central bank balance sheets can’t stay this inflated forever.

 

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
7/11/2017


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.






1/27/2017 – President Trump intends to reshape the relationship between the United States and Mexico. From building a border wall to renegotiating NAFTA, there is a lot of change about. I decided to write about the potential impact of a 20% import tax. This is not only intended to help educate others as to what is going on, but to also help me understand the scope of this potential changes. I understand that the “suggested” import tax is only a negotiating tool to help persuade Mexico to pay for the wall. However, an import tax like this would likely have some serious ramifications. This is a complex topic that is currently in flux so keep in mind that what is published today can easily change in the days or weeks ahead.

Trade: It’s important

This really shouldn’t be said, but trade between countries is extremely important. If done correctly, it promotes progress and prosperity for all involved. 74.7% of the United States’ total trade is from 15 countries alone, and Mexico is 3rd on that list (14.2%). In terms of exports, Mexico is our 2nd largest partner at 16.0% and they are our 3rd largest importing partner at 13.3%. In total, our total trade was $531B in 2015 with a trade deficit of -$58B.

US Export Partners

US Import Partners

From Mexico’s point of view, we are much bigger piece of their trading pie. The United States represents 81% of their exports and 48% of their imports.

Mexico’s Export Partners

Mexico’s Import Partners

A 20% import tax for Mexican goods entering the US would clearly hurt Mexico as this would affect 81% of Mexico’s exports. From a trade perspective, Mexico has much more to lose than the US would if President Trump were to make good on this threat. However, imports and exports represent only a piece of a country’s economy. Think back to your ECON 101 class. If you remember, the components of GDP are as follows:

GDP = Consumption + Investment + Government + Net Exports

Net Exports is imports minus exports. So, if a country were to have a trade deficit (like the U.S. has), then Net Exports would be a drag to the overall economy (-$58B deficit in 2015). When President Trump tweets about this deficit, this is what he is referring to.

The GDP Impact

Forecasting the overall impact of a 20% import tax is a near impossible thing.  One would assume that US consumers would be able to absorb come of the 20% price increase, but it is not that easy. Take, for example, the price of avocados. If Mexican avocados were to increase by 20%, I would assume that US consumers would buy Californian avocados instead. But, if the price of Toyotas being imported into the country were to increase by 20%, wouldn’t US consumers buy a Hyundai built in the US instead? Or perhaps another alternative? I don’t know. Nonetheless, I am still interested to see which country is more vulnerable and by how much. It is a relatively easy task to calculate the nominal impact for both the US and Mexico. So lets assume that a 20% tax increase on imports from Mexico to the US were only to affect those goods and not consumption, future investments, etc. just so we are able to see a hypothetical impact.

The $74B difference (total tax enacted per year) would definitely have an adverse affect for both the US and Mexico. Under this scenario, Mexico would enter into a recession with a -5.87% drop is production (again, assuming that all else is equal) and the US would feel a -0.39% reduction in economic expansion, but not a recession. Also notice that I did not include a $74B positive amount to the US Government line item (additional tax receipts) as these funds would theoretically go towards the cost of building a 2,000 foot wall.

There are a lot of other questions that I don’t have an answer for, but should be considered:

  • Are some of these exporting/importing companies able to absorb the 20% tax rate and not pass the cost along to the consumer? Additionally, would US consumers be able to absorb a higher cost? Would they look elsewhere for similar goods (likely)?
  • Would the number of goods and services drop if a 20% tax rate were enacted? (likely) Would Mexico be able to export these “lost” goods to other countries? Likewise, would the US be able to import these “lost” goods from other sources? Or, perhaps, would we be able to create these goods and services ourselves over time?
  • Would Mexico retaliate and enact an export tax on US goods, even though they rely on our country more than we rely on them?
  • What type of social impact would this have on US consumers?

The US is clearly in a position of strength and President Trump is likely using the threat of a 20% import tax as a bargaining chip. But if he were to make good on this threat, it would likely impact us more than he would realize.

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
1/27/2017


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.





11/25/2016 – President-elect Trump has promised to create over 25 million jobs over the next decade and to boost the U.S. GDP to an average rate of 3.5%. He plans to do so by reducing both corporate and personal income tax rates, cutting regulation and government spending, renegotiating trade deals, promoting American-sourced energy, and rebuilding the American infrastructure (well, at least $1 Trillion worth). In this blog post, I focus only on Trump’s tax plan. Market risks have shifted and there now exists a real chance that there will be a positive fiscal change (finally), which will ultimately help drive economic growth. I believe this is a game changer to both the stock and bond markets.

Trump’s Corporate Tax Change

Let’s begin with Trump’s proposed business tax policy. Simply put, Donald Trump hopes to lower the tax rate from 35% (at the upper end) to 15% across the board. There will be no more tax brackets nor a corporate alternative minimum tax.

current-corporate-tax-rates

trumps-proposed-corporate-tax-rate

Furthermore, Trump is also attempting to bring ashore the massive amount of U.S. company cash hoard, estimated to be $2.5T (CNBC). That is nearly 14% of the U.S. GDP! He is hoping to repatriate this cash at a one-time tax rate of 10%, which I suspect a lot of corporations will act upon.

Why is this tax policy such a big deal? The market is finally going to receive a more friendly fiscal policy. Since the end of the Great Recession, we have only had monetary policy to count on to help drive demand/growth. But now, it looks like we can finally count on fiscal help in the form of tax cuts.

Trump’s Corporate Tax Change – Impact To The Markets
It is no secret that the stock market is extremely expensive with a P/E ratio of 25.36. (I have written about this topic here if you are interested in learning more.) We are currently near record valuations as the S&P 500 has reached all-time new highs since Trump was elected president.

sp500-price-trump-president

But what does a Trump presidency mean for stock valuations? A lower corporate tax rate obviously means that corporations will be able to keep more of their profits. But how much more? What does this do to the market’s valuations? This is a more complicated question that it seems as there are a lot of factors driving the market. However, I attempted to quantify the change.

To better estimate the potential change, I figured it would be best to see how a lower tax rate would’ve affected the S&P 500 in the recent past (previous 12 months). Here are the facts:

  • The S&P 500’s Net Margin (Earnings/Sales) is 7.68% (TTM – June ’15-’16)

sp500-net-margin

  • While the corporate tax rate is 35% (highest bracket), the effective tax rate is 28% (Deutsche Bank)
  • The earnings yield is a low 3.94% and the TTM as reported current P/E ratio is an astronomical 25.36!

sp-500-pe-ratio-and-earnings-yield

  • The S&P 500 receives 33% of it’s profits from abroad, which means those profits are taxed at a different rate (blended 22.60%)

I highly suspect that Donald Trump will be able to pass a business tax rate of 15%, even with a Republican House and Senate eager to pass this law. Chances are, a rate closer to 20% will be pushed through. Nonetheless, the implications of a rate cut of this size are significant.

trump-tax-plan-difference

This 2.01% to 5.36% increase in S&P net margin brings the current net margin from 7.68% to 9.69% and 13.04%. In short, I believe this is what is currently driving the stock market higher. It is an immediate boon to the S&P’s bottom line.

The next question I asked is how this change would’ve affected the S&P 500? Let’s assume that Trump is able to pass a tax rate of 20% and the corporate earning’s margin is now 13.04% (up from 7.68%). That means that the S&P 500 earnings will increase from $86.92 to $147.55 per share.

The Stock Market Return With A Tax Cut

To better comprehend the implications of a business tax cut like this, I put together a sensitivity analysis showing the effect of a tax cut and the different P/E ratios. These numbers are as of 11/25/16.

trump-tax-rate-pe-ratio-return

Trump’s Proposed Individual Tax Policy

With a Republican-led House and Senate, Trump has a real shot at reforming the US tax code, which hasn’t been overhauled since 1986. As it currently stands, the highest federal tax bracket stands at 39.6%.Here is how the federal individual income tax code looks: 

individual-tax-rates-2016

If you live in California, the highest state income tax rate stands at 13.3%, making the grand total 52.9% (39.6% + 13.3%). At this rate, the U.S. has one of the highest income tax rates in the developed world, behind only Belgium, Finland, Sweden, Aruba, and Canada. We are taxed to death here in California, especially those at the higher end of the spectrum. As such, corporate and individual earnings has been finding ways around these high income tax rates (legally and some not-so-legally).

The goal for the U.S. is to stay competitive in the global economy. Though, this is an economy that has been slowing for a number of years. The Federal Reserve and it’s monetary tools has been doing everything within it’s power to spur demand. But this tactic can only work for so long. A revamp of the current tax code can really change things. And if anybody knows the U.S. tax code and it’s failings, it’s the man that has used and abused it for the past 30+ years.

Here is Trump’s proposed individual tax rates:

trumps-individual-federal-tax-rates

Under this plan, most individuals will pay less in taxes. Though, not everybody will save the same percentage amount. In fact, according to the Tax Policy Center, higher earners will save more than those at the lower brackets.

tax-break-by-percentage-trump-tax

Other changes in Trump’s Plan include:

  • Carried interest would be taxed as ordinary income
  • The 3.8% Obamacare tax would be repealed
  • The alternative minimum tax would be repealed
  • The standard deduction would be increased from $12,600 to $30,000 for joint filers, $15,000 for single filers
  • Personal exemptions will be eliminated
  • The head-of-household filing status will be eliminated
  • Itemized deductions will be capped for joint filers at $200K ($100K for single filers)
  • The death tax will be repealed, but capital gains held until death and valued over $10 million will be subject to tax. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives will be disallowed.
  • Childcare expenses for those under the age of 13 will be allowed as a deduction. This includes stay-at-home parents, grandparents, and paid caregivers. The Trump Plan also will allow Dependent Care Savings Accounts (DCSA), which will allow contributions to be free from taxation.

Bottom Line

Trump has yet to take the office and these tax cuts have yet to be realized. At this point, of course, this is all conjecture. However, keep in mind that the stock market (and all other markets) are forward looking. The market has begun to price in the possibility that a tax reform will occur soon. As the probability of a tax cut increases, the market will bake it into it’s price (positive or negative). I believe it is more likely than not that these tax cuts (in some shape or form) will get pushed through.

We are here to help you if you feel that you are not positioned correctly in this marketplace. Feel free to reach out.

 

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
11/25/2016


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.





11/3/2016 – A lot of my clients are buying real estate properties and renting them out as a strategy to help them with cash flow during retirement. So, I thought I would share what this strategy could look like.

The rental property question comes up more often than not. A lot of my clients envision themselves managing a small portfolio of rental properties while going into retirement. I suppose this goal crops up simply because we live in Southern California. Whatever the reason, investing in real estate is not for the faint of heart nor is it for those that are impatient. It usually takes years before cash flow turns positive on these investments. Nonetheless, I believe investing in real estate has its benefits, especially for those planning for strong cash flow during retirement. Keep in mind that I am not a real estate guru. I am not a local market expert, nor do I know if a specific home is going to increase in value or not. Nonetheless, I am a financial professional and I can quickly tell if a property (or a set of properties) is a good investment, given a few simple assumptions.

Before I begin, I wish to make it clear that I do not make any money if any of my clients invest in real estate. Bull Oak Capital is an Registered Investment Advisory firm. We do not participate in private/public REITS, partnerships, dealmaking, referral kickbacks, etc. I simply provide advice to my clients from a financial planning perspective. If renting out a property makes sense for a client, then I will recommend it. If it doesn’t, then I won’t.

Furthermore, I do not condone house flipping, speculative purchases, or any other type of short-term R.E. investing. I am also not condoning over-leveraging yourself. As with any other type of investment, leverage increases your risk and the potential to cause financial distress. The type of real estate planning I provide for my clients is a more conservative approach. I always plan for 20% down payments on all properties and the plan always includes a plan to pay off that debt in a reasonable amount of time. The goal is to become cashflow positive sooner rather than later, not to sell the home for a profit (though this is certainly a possibility).

Building out a real estate portfolio not only takes a time, but it also takes quite a bit of money. This is usually an option for those that have a large cash surplus at the end of the month after expenses are paid.

The Lure of Rental Income

Aside from the prospect of housing values increasing, the lure of real estate investing is the steady stream of income. In San Diego, the average apartment rental rate within the city is $2,123 per month. That number in itself is enough for those interested to begin planning. A side topic is whether or not the housing market is in a bubble. I do not know, but I suspect it is, along with most other asset classes. Nonetheless, I am intentionally ignoring current market conditions as I only hope to outline the economics behind rental properties. I am also intentionally ignoring what would happen if you were to sell a property for a gain. There are a number of tax consequences that should be considered, but that is a topic for another day.

One of the biggest headwinds to a successful retirement is inflation. If you were to retire at the age of 60 and to pass at the age of 90, that is 30 years of retirement. Let’s say that you had $1MM at retirement and you decided to keep your money in the bank, earning 0% interest. And let’s also assume that you did not touch it during those years (perhaps you were living off of another asset/income stream). What would happen to that $1MM during those years if inflation was 3% on average?

Purchase Power and Inflation

The same can also be true if one were to accept a fixed annuity during retirement. A fixed annuity does not change it’s monthly/quarterly/annual benefit. That means that the true value of that benefit diminishes over time if inflation is anything above zero.

This concept is simple, but it’s important to truly understand it. This is one of the primary reasons why we invest our funds at all; to beat inflation. Whether you are investing in stocks, or bonds, or anything else, the idea is to at least keep above the inflation rate (real return).

The Economics of Renting Out Properties

Let’s build out a model to see how this can play out. Assume that we have a 35 year-old client that is looking to buy properties and hopes to rent them out. The goal is for the client to become cash flow positive before retirement. The client would like to purchase a new property every 3 years before retiring (age 55). Here are the assumptions behind these projections:

re-assumptions

These assumptions are a bit conservative, making the positive FCF that much higher. That’s okay. It’s always better to build in conservatism in a model rather than to make overly optimistic assumptions.

Property Purchase Schedule

property purchase schedule1

As you can see, under this scenario, the client would be able to purchase 6 properties before retiring. The next step is to see what this cash flow would look like.

real-estate-cash-flow

I know this sheet is a bit daunting to look at, but focus on the last column, Net Income. This is the big takeaway from all of this. Of course, during those years when the client is putting down 20% on each property the cash flow is negative. But, over time as rental rates are increasing and as mortgages are being paid off, the free cash flow begins to grow.

The large numbers can be a bit deceiving as we are looking at cash flows that are far into the future. To help with this, here are the same numbers, but it todays 2016$ dollars (present value). These numbers help give you a better idea of what a real estate portfolio can generate in income.

pv-of-cash-flow

Managing Properties Is Not For Everybody

While owning a real estate portfolio can be advantageous, it also comes with its own risks and drawbacks. The most obvious ones are the ancillary costs:

  • Property taxes
  • Property Insurance
  • Property management company (if you choose to work with one)
  • Maintenance expenses
  • Etc.

Investing in real property also means that you are purchasing an illiquid asset. If you need to sell a property for whatever reason, it will likely take some time. Furthermore, the transaction costs are going to be astronomical. On average, you should expect ~6% for each buy/sell (3% for each selling agent).

The other obvious drawback is the headache of managing a property. Most of my clients work with property management companies to help separate themselves from this issue, but that costs money (usually 8-10% of gross rental receipts) and most management companies tend to slack off over time. I cannot overstate the importance of using a good property manager and leasing your home to good renters.

There is also concentration risk to consider. Most of the time, investors will accumulate a R.E. portfolio within a concentrated area (e.g. San Diego County). For example, if the local San Diego market were to tank (e.g. there is a recession, Qualcomm decides to leave the area, there is an earthquake, etc.), your entire portfolio will likely go down with the market.

That being said, I believe the pros outweigh the cons, if done correctly. Try to build a good team of professionals (financial advisor, real estate agent, mortgage broker, CPA, etc.) to work with you if you’ve never ventured into this field before. And of course, please take the long-term view if you do decide to pull the trigger!

 

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
11/3/2016


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.





9/6/2016 – Most investors have only a mix of stocks and bonds in their portfolios. This is because stocks and bonds have historically had a negative correlation. Since 2008, the SPDR S&P 500 ETF (SPY) and the iShares 20+ Year Treasury Bond ETF (TLT) has had a negative correlation of -43%. (Bull Oak Capital)

On days when the S&P 500 was down, Treasury bonds were more likely than not to help dampen those negative days. This is the whole point behind diversification. By not having all of your eggs in one basket, you reduce your risk by splitting your money between these two different asset classes. Remember, owning a stock is to own an equity stake in a corporation. To own a bond is to own a debt instrument. They are two completely asset classes that are supposed to behave differently. This behavior provides safety.

Stocks And Bonds Are Pricey

Since 2008, both stocks and bonds have provided impressive returns. In fact, TLT (the long-term Treasury ETF) has posted a more impressive return than SPY (the S&P 500 ETF).

SPY vs TLT Returns

All of this has been accomplished while still maintaining a negative correlation. The problem with the current scenario, though, is that both asset classes are now very expensive. The TTM S&P 500 P/E ratio is 25.29 (www.multpl.com). The 10-yr Treasury currently yields 1.55% and the 30-yr yields 2.24%. Remember, as bond prices go up, bond yields go down. The outlook for both bonds and stocks look bleak at best, at least under the current environment.

The Risk

In my opinion, the 2013 Taper Tantrum is an event that should be on top of every portfolio manager’s mind. During this phenomenon, bond yields spiked as the Federal Reserve reduced the amount of money it was feeding into the economy.  There was also a sharp reversal in the stock and bond correlation.

Correlation

Of course, the Federal Reserve stepped in quickly to quell any pricing concerns. The markets were cheaper back then and forward looking earnings expansions were reasonable.

However, in our current market environment, both stocks and bonds are expensive. The stock market is at its all-time high and the expectation that corporate earnings growth will continue is muted. Treasury yields are at historic lows and they are very sensitive to any type of interest rate movement. Furthermore, the Fed is expected to do very little to help accommodate asset price growth. in fact, they are expected to do the opposite by normalizing interest rates.

If your investment strategy is hinged on the idea that stocks and bonds will remain negatively correlated, despite the circumstances, you should probably rethink your reasoning. A market with rising rates would not help either asset class. A worse-case scenario is one where inflation were to pick-up. Under this situation, both stock and bond prices would be under pressure. The volatility of a standard 60/40 stock/bond portfolio would increase as the correlation of stocks and bonds increase.

That being said, this central bank-induced party may continue for quite some time. The Fed, the ECB, the BOJ, and other global central banks are very powerful entities. They may continue this NIRP/ZIRP policy for another month, another year, or even another 5 years. Who knows. But with both stock and bond prices at all-time highs, the risk/reward ratio is highly unfavorable. If interest rates do rise (Fed induced or not) or if faith in the central banks begin to wane, there is a lot of pain to be had.

The threat of an asymmetrical stock and bond selloff is too great to ignore. I believe it is wise to consider these risks more closely.

 

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
9/6/2016


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.