Nola Kulig
Kulig Financial Advisors
Longmeadow, MA, 01116 USA
413-565-2839
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2016 Q4 Market Review: A Year of Thwarted Forecasts

January 23rd, 2017

This is our review of the markets for fourth quarter and year of 2016. As you know, we do not believe in making forecasts, but we comment on cross currents influencing the markets. As usual, our goal is to look at recent market results, put them in perspective, and see how that experience should set our expectations going forward.

We look at the following topics:

  • 2016 Q4 and Year-to-Date Markets Review
    • Summary of Returns
    • The Markets’ Twists and Turns in 2016
  • What Does all This Mean?
  • Conclusion

2016 Q4 and Year-to-Date Market Review

Summary of Returns

As I write this review of the markets in 2016, some trends from the fourth quarter are already waning. Nonetheless, looking at what we experienced last year may be instructive as we look at the year ahead.

Last year was a tough one for prognosticators and strategists. There were so many twists and turns from a macroeconomic and political perspective that many experts, pollsters and forecasters had their hands full. Those activities are usually fraught with peril, as the error rate is high, but last year seemed worse than usual.

By now, it is old news how wrong the experts were about Brexit and the US election outcome. Not only that, but if they managed to call the Trump victory correctly, they usually got the market’s reaction wrong. Rather than nose diving, the stock market took off and headed for record territory.

Some additional observations from the table of returns, which follows:

  • The 12-month return for the S&P 500 Index of 12.0% was well above the long-term historical average since 1926 of 10.1%
  • In the US, small cap companies led the way, followed by medium-sized companies.
  • Style indexes are not shown, but value trumped growth (pun intended).
  • Emerging markets did well for the year, despite declining after Trump’s election win.
  • Developed markets outside the US rebounded in the fourth quarter, but still turned in a poor year.
  • High quality bonds did poorly, based on an outlook of increasing rates.
  • US Real estate investment trusts (REITs) did surprisingly well, considering their higher yielding nature and a consensus outlook for higher rates.
  • Master limited partnerships continued to benefit from both a firming in energy prices and investors’ hunt for income.
  • Commodities in general did well, with a firming US economy and an emerging consensus of further growth and firming inflation.
  • Despite declining in the fourth quarter, gold held onto positive results for the year.
Market Returns
Market Index December Q4 2016 2016
Stocks        
Large Cap S&P 500 Index 2.0% 3.8% 12.0%
Midcap S&P Midcap 2.2 7.4 20.7
Small Cap S&P Small Cap 3.4 11.1 26.6
Non-US Developed Markets MSCI EAFE 3.4 -0.7 1.0
Emerging Markets MSCI Emerging Mkts. 0.2 -4.2 11.2
US Bonds Bloomberg Barclays US Aggregate 0.1 -3.0 2.7
REITs S&P US REIT 4.7 -3.0 8.5
MLPs Alerian MLP 4.4 2.0 18.3
Gold S&P GSCI Gold Sub index Total Return -1.9 -12.7 7.8
Commodities S&P Dow Jones Commodity Index TR 1.3 3.8 13.3

Sources: AJO Partners, Factset, S&P Dow Jones Indexes

The Markets’ Twists and Turns in 2016

When we see the extremely strong finish for stock markets in 2016, it is worth recalling that it started out in a very rocky fashion, with comparisons to 2008 that were too numerous to count.

Markets later had to deal with the UK’s decision on whether to stay in the European Union. Pollsters predicted the country would remain, but instead we got Brexit, which is still a long-term proposition in terms of its eventual impact. We counseled maintaining your asset allocation through this period, and not making any brash moves. While the markets initially reacted strongly, once they got over the shock, they began to function normally again.

In fact, in the months leading up to the November US presidential election central bank policy produced considerable calm in the markets. In our last quarterly review, we questioned how long the “eerie calm” could last, as an environment where trading volume is low and most asset classes rise together cannot go on indefinitely. But it is impossible to forecast when and how it might end.

When it did end, it was fortunately to the upside. When Donald Trump won the election, stock markets initially lurched downward. Then they turned sharply upward, and the rest, as they say, is history. A consensus view emerged that Trump policies of infrastructure spending, reduced regulation and tax reform would kick start the US economy out of the low growth rate it has experienced since the Great Recession. Rather than deflation, we might need to focus on the potential for inflation, and with it, higher interest rates. The focus moved decidedly from Fed watching to Trump watching.

The only problem with this consensus view is that we aren’t there yet. As I write, Trump will be taking office in a few days, his cabinet still needs approval, and he has already had to revise some policies. Since we have a democratic government, his proposals will be subject to considerable debate, even though we have a Republican majority in both houses and a Republican president. In just the last week, the “Trump trade” has begun to recede, as markets got ahead of themselves. While we may ultimately get to where Trump wants us, the markets may have already fully priced most of that scenario into asset values.

What Does All This Mean?

The unpredictability of last year was a textbook example of why investors need fully diversified portfolios. If one had taken forecasters seriously, a lot of money could have been left on the table or outright losses experienced.

For example, a prospect (now client) came to see me in November, just prior to the election. He was getting to know several advisors as part of his selection process. One had recommended that the client liquidate a good portion of his portfolio on the supposition that if Trump won, it would negatively impact the markets. What did I think?

Long term readers of this newsletter and clients already know how I responded. Extreme changes in your asset allocation are rarely warranted, if you have carefully selected it based not only on your aptitude for risk, but as important, your capacity to bear risk.

Moreover, forecasting in general has a low batting average, especially in the political or macroeconomic realm. These are very difficult issues to fully analyze and get right. Not only that, but one can construct a completely cogent and thorough analysis and yet misread what market consensus really is, or how much is in asset prices.

I responded that the advisor in question could possibly be correct, but there was an equal chance he could be wrong. So to make an extreme change in a portfolio with no hedge in case of a potentially faulty forecast is a risky approach. If there is one thing I have learned, it is how often the markets can fool us. Also, we should avoid building what might be called a “single scenario” portfolio—one that has to have a specific set of conditions met for it to be correct. Instead, it should be as much as possible an “all weather” portfolio, with components that will help it weather different types of markets, since we can never really be certain in advance what may come our way.

So my new client did not liquidate most of his portfolio and is better off for it. We did, however, make some other adjustments based on his unique needs and circumstances.

Conclusion

Last quarter, we noted in that we expected volatility to rise as markets sort things out. Factors contributing to that view were that we were in an election year where the race was hotly contested, and there was some uncertainty regarding Federal Reserve policy.

Now that the election is behind us, things look no more certain than they did last year, despite the market’s reaction to the Trump victory. Now we will really see what the new administration can do, how the economy will fare, what the Fed will do, etc. And let’s not forget factors outside the US—the state of China’s economy, rising nationalism in Europe, and central bank policy outside the US.

Need I say more to make the case for a diversified portfolio?

We would reiterate to make sure you are at your recommended risk level and asset allocation for your portfolio. If you are, then all is well, and you can focus your attention elsewhere. If not, please make adjustments so that you are. And last but not least, if you are not sure, please call and let’s see where you need to be.

Thank you very much for your trust and confidence. We look forward to working with you in 2017. Happy New Year!

Your 1040: What it Says About You

May 1st, 2015

It was with a sigh of relief that I completed our family’s tax work this year (full disclosure: we have a CPA prepare ours, but I did my mother’s—-hers is simpler, and it saves her a bit of money).

However, rather than just filling out the forms to get the job done, a careful review of your 1040 can frequently reveal some tax-savings steps you can take. Many are simple; others, if not complex, may mean some extra work on your part (or your advisors), but can be well worth the effort.

The following are just a sampling, given the complexity of the tax code. These are the more straightforward items from the first page of Form 1040. Why focus on this page? At the bottom is an important number: adjusted gross income (AGI). AGI is important because it determines whether you can claim certain deductions and credits.

If you prepare your return yourself, you should be in a good position to evaluate what you can do in the following areas. If not, at a minimum, you will want to review your return and discuss things with your tax advisor; one of the most telling questions is “what can I do to reduce my taxes for 2015?”

Line by Line

Line 7 – Wage, Salaries and Tips

This first step you can take to reduce taxes (assuming you are employed) doesn’t even show on line 7–wages, salaries and tips. That is because it has to do with your 401(k) contributions.

Assuming you are contributing to a traditional (not Roth) 401(k), these contributions are not reported on your line 7. Instead, they reduce your salary or wages. So the first obvious solution to reducing taxes is to make sure you are maximizing your 401(k) contributions. The fact that you may get an employer match on your savings is a bonus.

Lines 8a and 8b, Taxable and Tax Exempt Interest

Take time to evaluate the mix of taxable and tax exempt interest on your return. The proportion of each that is desirable depends on your tax bracket and the level of interest available on each. Each time you consider an interest-bearing savings account or investment, you should compare it to the tax-equivalent yield for a tax exempt investment to that available on a taxable one to see which is best for you.

The calculation for taxable-equivalent yield is:

 Tax equivalent yield = tax-free municipal bond yield/(1-tax rate)

The tax rate referred to in this equation is your marginal rate (which you can think of as the rate of tax you pay on each additional dollar of income—this is not your average tax rate, which would be your total tax divided by total taxable income). Your marginal tax rate can be determined by reviewing the tax tables at www.irs.gov. This is a good number to know for all sorts of financial planning questions.

In general, those in higher tax brackets usually benefit from having more tax exempt interest, while those in lower brackets usually are OK with more taxable interest. So if you are in a high tax bracket and have lots of taxable interest on your 1040, it may be time adjust your portfolio. Likewise, if you are in a lower tax bracket, but were attracted to tax exempt bonds to lower your tax bill, make sure you have not unnecessarily sacrificed interest income.

Since rates change constantly, there are times where even lower bracket tax payers may benefit from municipal bond income, so please check every time you consider making an investment.

Lines 9a and 9b – Total Dividends and Qualified Dividends

Your tax here depends on what kind of dividends you’re receiving: qualified or non-qualified.

Most dividends can be referred to as “ordinary” or “non-qualified” dividends, and they’re going to be taxed like any other income you report.

This brings us to qualified dividends, which have their own tax requirements and exceptions. The good news about qualified dividends is that they’re taxed at a lower rate. They’re considered capital gains, because you have to hold your stock for a certain number of days.

Your tax bracket is going to influence your qualified dividends tax rate. And here’s something nice: If you’re in the 10 to 15 percent bracket, then you’re not going to be taxed anything on qualified dividends. If you’re in the 25 to 35 percent tax bracket, your qualified dividends will be taxed at 15 percent. In a bracket above 35 percent? Well, lucky you – but you’ll have to pay 20 percent on those qualified dividends and long-term capital gains, but this is still lower than regular income tax rates.

When selecting investments, you don’t want to have the tax tail wag the investment dog. But in your taxable accounts, if you have a choice between equivalent investments that will pay qualified dividends versus those that do not, it is clear which you would want to choose.

Is this giving you a hint about where you want to own different investments? The issue of where to hold your investments to the best tax advantage is called “tax location.” In general, you want to hold interest bearing investments where the income is taxed at regular income rates in tax deferred (traditional IRAs, 401(k)s, etc.) and those potentially taxed at capital gain rates in taxable accounts. You want to benefit from capital gains rates as much as possible in taxable accounts.

Line 13 – Capital Gain or Loss

As mentioned earlier, capital gains are taxed at rates lower than those for regular income. You can also use losses to offset gains as follows:

  • Offset capital gains that were held less than a year by using your current capital losses. These are call short-term gains and taxed at your regular income tax rate at whatever tax bracket you are in.
  • Use the remaining losses to offset the gains that were held more than a year. These are long-term gains and eligible for the capital gains tax rate.
  • If your losses exceed your gains, you may deduct up to $3,000 of losses on your current year tax return.
  • Losses in excess of your gains and your $3,000 allowance can be carried forward to next year. With the excess, you can offset next year’s capital gains or use up to another $3,000 loss.

Line 25 – Health Savings Accounts

health savings account (HSA) is a tax-advantaged medical savings account available to taxpayers who are enrolled in a high-deductible health plan. The funds contributed to an account are not subject to federal income tax at the time of deposit. HSA funds may currently be used to pay for qualified medical expenses at any time without federal tax liability or penalty. Withdrawals for non-medical expenses are treated very similarly to those in an individual retirement account (IRA) in that they may provide tax advantages if taken after retirement age, and they incur penalties if taken earlier.

A full discussion of considerations of whether an HSA is appropriate for you is beyond the scope of this short discussion. But it is something worth researching and determining whether it is appropriate for your situation. If so, you have an opportunity to reduce your AGI.

Line 28 – Self Employed SEP, SIMPLE and Qualified Plans

If you work for yourself rather than for an employer, there are still tax incentives to save for retirement. If you have not established a plan for any self-employment income, consider increasing your retirement security and reducing your AGI at the same time.

Line 29 – Self Employed Health Insurance Deduction

We are all required to have health insurance since the introduction of the Affordable Care Act. If you are self-employed, you can receive a tax deduction for the premiums.

Some of us pay quite a lot to insure a family, even when it is through an employer plan. If you have a spouse with self-employment income, you may want to check whether your after-tax premiums are lower if the spouse takes out his/her own health policy. You may even want to check on insuring the family through that policy, depending on your circumstances.

Line 32 – IRA Deduction

If you don’t have an employer 401(k), or if you can save over and above those contributions, you may be able to use an Individual Retirement Account and deduct that contribution. Income levels and other factors affect your ability to take a deduction, so please check the rules and use the worksheets to calculate whether you can take one or not.

Summary

This is hardly an exhaustive list of ways to save on your taxes. But a simple review of a few key items has potential to help save you money the next time April 15th comes around.

On that note, let’s look forward to spring, with taxes done, planning for next year complete and warmer weather on the way!

Nola Kulig, CFA, CFP® accepted for Membership in the National Association of Personal Financial Advisors (NAPFA)

June 26th, 2014

Local Financial Advisor Joins Leading Association of Fee-Only Financial Planners

Nola Kulig of Kulig Financial Advisors in Longmeadow, MA has been accepted for membership in the NATIONAL ASSOCIATION OF PERSONAL FINANCIAL ADVISORS (NAPFA). With membership, Kulig becomes affiliated with an organization of more than 2,400 of the most-qualified financial advisors in the nation who deliver objective, Fee-Only advice.

Membership in NAPFA and the NAPFA-Registered Financial Advisor designation are available only to Fee-Only financial advisors who meet NAPFA’s stringent membership qualifications. Those standards require advisors to receive compensation only directly from their clients, to act in clients’ fiduciary interests at all times, and to provide comprehensive planning services. In addition, NAPFA has some of the industry’s most rigorous education and training requirements. NAPFA’s continuing education requirements also exceed those of any other association of financial advisors.
“I congratulate Nola for demonstrating her dedication to provide effective, transparent, client-centered services by upholding the high standards that NAPFA sets for all its members,” said NAPFA Chair Linda Leitz.

Investment advisor representative of an investment advisory services offered through Garrett Investment Advisors, LLC, a fee-only SEC registered investment advisor. Tel: (910) FEE-ONLY. Kulig Financial Advisors may offer investment advisory services in the state of Massachusetts and other jurisdictions where exempted.