2018 First Quarter

Kreitler Financial:

2017 will be remembered as a year that almost everything went right for the economy and the markets. US growth accelerated, with GDP expanding by more than 3% in the second and third quarters. The unemployment rate declined to 4.1%, the lowest seen in 17 years. Growth was a global trend, and for the first time since the 2008 Financial Crisis all 45 countries tracked by the OECD were on track to have positive growth for the year.

2017 will also be remembered for its political discord. After the 2016 election, we wrote in our 2017 First Quarter Newsletter: “Now, investors will begin to pay more attention to the actual implementation of specific policies than to Trump’s announcements as they adapt to the new President’s theatrical style.” We were partially right. We were too optimistic for the possibility of bi-partisan compromise, which has not played out. Instead the Republicans in Congress negotiated an uncomfortable partnership with an unusual President. They failed in their efforts to reform or repeal the Affordable Care Act (Obamacare). They had successes in other areas, such as passing the Tax Cuts and Jobs Act, the largest tax reform since the 1980s. The Trump administration made good on one of his campaign platforms and reduced regulation, just as significantly reducing the issuance of new regulation.

2017 Market Review

Investors generally liked what they saw in 2017, and stock markets around the world responded with terrific growth. If you remember back to the beginning of 2017, this was not at all expected.

Annualized 2017 returns

Bloomberg Barclays US Aggregate Bond Index


S&P 500 Composite Index


Russell 2000 Index


MSCI EAFE (TR) Gross Index


MSCI EM (Emerging Markets) Gross Index


NCREIF – National Index


*Source: Tamarac

Markets are related to the real economy and tend to lead it as investors attempt to predict future profits and growth. In 2017, US markets had their best performance in years. Global markets also had strong years, and the emerging markets surged as they overcame concerns over trade restrictions.

This terrific performance occurred in an environment with extremely low volatility. Global equity markets as measured by the MSCI All Country World Index did not have a single down month. On a total return basis (including dividends), the S&P 500 is now on a 14-month streak of positive returns through December 2017. This lack of volatility is highly unusual. MarketWatch observed the last time markets were this quiet was when the Beatles made their debut on the Ed Sullivan show in 1964. Investors should not let this lack of volatility lull them into complacency.

A small surprise to us was bond yields, which remained more or less stable for 10-year Treasuries. We have positioned bonds in portfolios in anticipation of possible rising interest rates. These strategies generally worked even while rates remained stable. We continue to believe that rates are in a long-term bottoming process.

Market returns are always uneven and unpredictable. 2017 was a year in which having exposure to risk assets such as stocks paid off. Risky assets have historically received higher returns over long periods to compensate investors for their risks. Investors need strategies that permit them to hold these assets over the long run, even when the news cycle makes things uncomfortable.

What to expect going forward?

Investor sentiment swung bullish fairly quickly in the fourth quarter of 2017. Some people are asking the question of whether markets have run up too high and stock exposure should be trimmed.

We think investors should expect greater market swings than the unusually low volatility we experienced in 2017. A correction would be normal and even healthy. Volatility is not something that long-term investors should fear, but rather manage. It is this very risk that gives stocks their greater long term historical performance relative to less risky asset classes like bonds. With 10-year Treasury yields around 2.4%, expected returns for stocks remain relatively attractive. A good investment strategy should include sufficient liquidity in the form of cash and high-quality bonds that the investor can ride through the inevitable periods of stock market uncertainty.

Some market observers believe we are in a structural bull market. In the past, these have lasted upward of fifteen years, with market values increasing by as much as 8 times. The current bull market has been in place since 2009 with market values increasing over 3 times. The final legs up of a bull market can lead to dramatic market gains.

In the past, structural bull markets have been punctuated by bear markets, some of them severe. As investors, we must expect these market drops. Investors have been rewarded by focusing on the long term, managing liquidity for shorter term needs, and controlling portfolio risk to a level they are comfortable riding through inevitable market drops. Of course, there are no guarantees in investing, but the biggest regrets of the past two years may well be from those investors who let personal opinions influence their investment strategies and missed the strong stock returns since February 2016.

We continue to believe the long-term bias for bond interest rates is up. Rising rates cause bond prices to fall and current low yields do not provide much return. In the past, bonds could provide both safety and return, but in this low rate environment they cannot provide both simultaneously.

What could upset the current relatively benign investment environment? The consensus view among market observers is that the economy and markets can continue to expand for some time. Historically major expansions have ended when interest rates become higher than the economy can bear.  The Federal Reserve tightens rates too quickly, killing growth. An alternate scenario is that they tighten too slowly, resulting in higher inflation that drives interest rates higher.

Neither of these seem likely in the short term. Other possible disruptions could be an unexpected geopolitical event, the ever-present risk of a major policy mistake in Washington, a trade war, worse than expected economic effects of Brexit, or an oil price shock. An interesting possibility is that the very lack of volatility may encourage investors to reduce their caution, which could accelerate selling when the inevitable market declines do occur.

In summary, we continue to be optimistic, while recognizing that risk control is always critical. An investment strategy should never be based solely on a forecast.

Planning Topics: The Tax Cuts and Jobs Act of 2017

Republicans passed the largest tax reform bill since 1986 in December. The majority of Americans will see their income tax bills go down, but the benefits are uneven. The bill is very complex, and more information will become available along with new strategies for managing taxes.

The biggest impact on the economy may be the changes on corporate taxes. The bill reduced corporate income taxes from their previous 35% rate to 21%. Taxes moved to a territorial system, a change meant to level the playing field with the way the rest of the world taxes corporate income.  The expected benefit is to tax companies’ currently untaxed foreign earnings and to encourage companies to return those earnings to the US. We think these changes will have a positive effect on the economy and the markets over the long term. A one-time tax on previously untaxed foreign earnings was also included.

Individuals face a number of significant changes that will require planning. While this is not intended to be a comprehensive review, a few of the more important points for income tax filers are:

  • Rates were cut at most levels of income, and brackets were expanded, resulting in a tax cut for most filers. This will be felt almost immediately with lower withholding rates issued by the government.
  • State and local tax (SALT) deductions are capped at $10,000 per couple. In high tax states like Connecticut, this may offset the rate reduction for high earners and those with high property taxes, and some filers may pay more.
  • Capital gains and dividend tax thresholds remain unchanged.
  • The standard deduction increased to $24,000 for couples, and personal exemptions were eliminated. Many filers will not benefit from itemizing deductions.
  • Pass through businesses such as S-Corporations and LLCs receive a deduction for a portion of their pass-through income, with limits on personal service companies. Owners of pass through businesses should consult their tax adviser to see if they are able to take advantage of this.

Rules for college savings 529 accounts were changed to permit up to $10,000 per year to be used to fund elementary or secondary private school. The actual utility of this may be limited, since the biggest benefit of the 529 plans may be time invested in the market to maximize their tax-free growth.

The Federal estate and gift tax exemptions were increased to $11.2mm per person. Separately, Connecticut changed its estate tax rules to unify it with the Federal exemption amount over the next three years, although without portability of the exemption between spouses if the first spouse dies without using their full exemption. These changes result in fewer individuals subject to both federal and state estate taxes, and therefore create opportunity to simplify estate plans in many cases.

We expect significant tax rate volatility as tax rules continue to change. The bill was passed without any Democratic support, making it politically vulnerable, although the tax cut may be popular when workers see it in their paychecks. If the hoped for economic growth does not materialize, the bill is likely to increase the national debt and make it challenging to renew some provisions when it’s individual tax cuts sunset in 2025. Some of its provisions have their own sunset dates. Individuals will need to adapt their planning strategies to the expected changes. Investors should stay flexible and try to diversify their tax exposure by using a combination of tax deferred, after tax, and tax-free accounts so they have more control over when to realize income. Putting assets into the most preferential account to derive the best after-tax return, such as we do for our custom client portfolios, will be increasingly important in this type of environment.

Portfolio Rebalancing Changes

In 2017 we rolled out our new portfolio management and reporting solution from Envestnet Tamarac. Clients received their first look at it this fall with the introduction of new consolidated statements and online reporting tools. If you have not yet seen the online portal, please contact us for a demo and to set up your login.

The investment team is already using this powerful tool for portfolio management to increase the frequency with which we monitor our portfolios and our ability to fine tune them. The changes are largely behind the scenes, but the hoped for benefits to clients will be continued customization around tax situation and account location, more proactive management of portfolio risk, reduced trading and related costs (like taxes), and an increased ability to take advantage of market and tax opportunities. Historically we rebalanced each client portfolio two times per year to implement any changes. Now we are monitoring portfolio asset allocation on a continuous basis. When an individual portfolio drifts outside its acceptable target allocation range, we review what changes should be made.

Happenings at Kreitler Financial

Thank you to the many clients and friends who joined us in October to hear Andy Friedman of The Washington Update at the New Haven Lawn Club. Andy presented an informative and entertaining look at the state of politics and policy, as well as some predictions on what to expect going forward. He has correctly predicted the Republicans would pass the tax bill and provided a number of potential strategies that individuals should consider to address potential tax rate volatility.

Sandy Blanchard, our Operations Manager, celebrated her 10-year anniversary with Kreitler Financial.

Charlie was named to the Raymond James Global Top 50, a select group of the top producers across Raymond James’s multiple divisions. He also attended the Advanced Planners Study Group in December to share ideas with other top professionals.

We wish you a happy, healthy and prosperous 2018.

With warm regards,

Charles F. Kreitler, CFP®
Robert P. Kreitler, CFP®
Founding Partner

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Charles and Robert Kreitler, CFP and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing involves risk and investors may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Russell 2000 index is an unmanaged index of small cap securities which generally involve greater risks. The MSCI EAFE is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The MSCI Emerging Markets Index is designed to measure equity market performance in 25 emerging market indexes. The Barclays Capital US Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS, and CMBS. The NCREIF Property Index (NPI) is a quarterly, unleveraged composite total return for private commercial real estate properties held for investment purposes only. The MSCI ACWI (All Country World Index) is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. Inclusion of any index is for illustrative purposes only. Individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Past performance does not guarantee future results. RJFS does not provide tax advice. You should discuss any tax matters with the appropriate professional. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investments mentioned may not be suitable for all investors. There is no guarantee that any statements, opinions or forecasts provided herein will prove to be correct.

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